With its stock down 27% over the past three months, it is easy to disregard Shanghai Yongmaotai Automotive Technology (SHSE:605208). It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. In this article, we decided to focus on Shanghai Yongmaotai Automotive Technology's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How Do You Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Shanghai Yongmaotai Automotive Technology is:

2.9% = CN¥60m ÷ CN¥2.1b (Based on the trailing twelve months to September 2023).

The 'return' refers to a company's earnings over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.03.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company's earnings growth potential. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Shanghai Yongmaotai Automotive Technology's Earnings Growth And 2.9% ROE

It is hard to argue that Shanghai Yongmaotai Automotive Technology's ROE is much good in and of itself. Not just that, even compared to the industry average of 7.6%, the company's ROE is entirely unremarkable. For this reason, Shanghai Yongmaotai Automotive Technology's five year net income decline of 15% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.

So, as a next step, we compared Shanghai Yongmaotai Automotive Technology'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 5.0% over the last few years.

Earnings growth is a huge factor in stock valuation. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Shanghai Yongmaotai Automotive Technology is trading on a high P/E or a low P/E, relative to its industry.

Is Shanghai Yongmaotai Automotive Technology Making Efficient Use Of Its Profits?

Shanghai Yongmaotai Automotive Technology's low three-year median payout ratio of 13% (or a retention ratio of 87%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. This typically shouldn't be the case when a company is retaining most of its earnings. So there could be some other explanations in that regard. For example, the company's business may be deteriorating.

In addition, Shanghai Yongmaotai Automotive Technology has been paying dividends over a period of three years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.

Conclusion

Overall, we have mixed feelings about Shanghai Yongmaotai Automotive Technology. 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. Our risks dashboard would have the 3 risks we have identified for Shanghai Yongmaotai Automotive Technology.

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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.