Zhejiang Zhenyuan ShareLtd (SZSE:000705) has had a rough month with its share price down 34%. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Stock prices are usually driven by a company's financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Specifically, we decided to study Zhejiang Zhenyuan ShareLtd's ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.
How Is ROE Calculated?
Return on equity can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Zhejiang Zhenyuan ShareLtd is:
5.1% = CN¥101m ÷ CN¥2.0b (Based on the trailing twelve months to September 2023).
The 'return' is the yearly profit. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.05 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
Zhejiang Zhenyuan ShareLtd's Earnings Growth And 5.1% ROE
On the face of it, Zhejiang Zhenyuan ShareLtd's ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 7.9% either. For this reason, Zhejiang Zhenyuan ShareLtd's five year net income decline of 7.2% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.
So, as a next step, we compared Zhejiang Zhenyuan ShareLtd's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 7.0% over the last few years.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is Zhejiang Zhenyuan ShareLtd fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Zhejiang Zhenyuan ShareLtd Making Efficient Use Of Its Profits?
Despite having a normal three-year median payout ratio of 26% (where it is retaining 74% of its profits), Zhejiang Zhenyuan ShareLtd has seen a decline in earnings as we saw above. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.
Moreover, Zhejiang Zhenyuan ShareLtd has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.
Conclusion
In total, we're a bit ambivalent about Zhejiang Zhenyuan ShareLtd's performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. You can see the 3 risks we have identified for Zhejiang Zhenyuan ShareLtd by visiting our risks dashboard for free on our platform here.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.