Guizhou Guihang Automotive Components Co.,Ltd's (SHSE:600523) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

Most readers would already be aware that Guizhou Guihang Automotive ComponentsLtd's (SHSE:600523) stock increased significantly by 12% over the past week. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on Guizhou Guihang Automotive ComponentsLtd's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Guizhou Guihang Automotive ComponentsLtd

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Guizhou Guihang Automotive ComponentsLtd is:

5.7% = CN¥173m ÷ CN¥3.0b (Based on the trailing twelve months to March 2024).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.06 in profit.

Why Is ROE Important For 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of Guizhou Guihang Automotive ComponentsLtd's Earnings Growth And 5.7% ROE

At first glance, Guizhou Guihang Automotive ComponentsLtd's ROE doesn't look very promising. Next, when compared to the average industry ROE of 8.2%, the company's ROE leaves us feeling even less enthusiastic. As a result, Guizhou Guihang Automotive ComponentsLtd reported a very low income growth of 4.2% over the past five years.

We then compared Guizhou Guihang Automotive ComponentsLtd's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 8.9% in the same 5-year period, which is a bit concerning.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Guizhou Guihang Automotive ComponentsLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Guizhou Guihang Automotive ComponentsLtd Using Its Retained Earnings Effectively?

Despite having a moderate three-year median payout ratio of 37% (implying that the company retains the remaining 63% of its income), Guizhou Guihang Automotive ComponentsLtd's earnings growth was quite low. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, Guizhou Guihang Automotive ComponentsLtd has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Summary

In total, we're a bit ambivalent about Guizhou Guihang Automotive ComponentsLtd's performance. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the 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. To know the 1 risk we have identified for Guizhou Guihang Automotive ComponentsLtd visit our risks dashboard for free.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com