Shandong Linglong Tyre Co.,Ltd.'s (SHSE:601966) Financials Are Too Obscure To Link With Current Share Price Momentum: What's In Store For the Stock?

Shandong Linglong TyreLtd (SHSE:601966) has had a great run on the share market with its stock up by a significant 16% over the last three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to Shandong Linglong TyreLtd's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Shandong Linglong TyreLtd

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 Shandong Linglong TyreLtd is:

9.8% = CN¥2.1b ÷ CN¥22b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.10 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Shandong Linglong TyreLtd's Earnings Growth And 9.8% ROE

At first glance, Shandong Linglong TyreLtd's ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 8.3%. But then again, Shandong Linglong TyreLtd's five year net income shrunk at a rate of 10%. Bear in mind, the company does have a slightly low ROE. Therefore, the decline in earnings could also be the result of this.

However, when we compared Shandong Linglong TyreLtd's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 9.2% in the same period. This is quite worrisome.

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 Shandong Linglong TyreLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Shandong Linglong TyreLtd Efficiently Re-investing Its Profits?

Looking at its three-year median payout ratio of 30% (or a retention ratio of 70%) which is pretty normal, Shandong Linglong TyreLtd's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

In addition, Shandong Linglong TyreLtd has been paying dividends over a period of seven 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 Shandong Linglong TyreLtd. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.