Optimism for Shanghai Lianming Machinery (SHSE:603006) has grown this past week, despite three-year decline in earnings

One simple way to benefit from the stock market is to buy an index fund. But if you buy good businesses at attractive prices, your portfolio returns could exceed the average market return. Just take a look at Shanghai Lianming Machinery Co., Ltd. (SHSE:603006), which is up 35%, over three years, soundly beating the market decline of 6.5% (not including dividends).

Since the stock has added CN¥320m to its market cap in the past week alone, let's see if underlying performance has been driving long-term returns.

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In his essay The Superinvestors of Graham-and-Doddsville Warren Buffett described how share prices do not always rationally reflect the value of a business. By comparing earnings per share (EPS) and share price changes over time, we can get a feel for how investor attitudes to a company have morphed over time.

Over the last three years, Shanghai Lianming Machinery failed to grow earnings per share, which fell 29% (annualized).

This means it's unlikely the market is judging the company based on earnings growth. Therefore, we think it's worth considering other metrics as well.

You can only imagine how long term shareholders feel about the declining revenue trend (slipping at 7.2% per year). The only thing that's clear is there is low correlation between Shanghai Lianming Machinery's share price and its historic fundamental data. Further research may be required!

The graphic below depicts how earnings and revenue have changed over time (unveil the exact values by clicking on the image).

If you are thinking of buying or selling Shanghai Lianming Machinery stock, you should check out this FREE detailed report on its balance sheet.

What About Dividends?

As well as measuring the share price return, investors should also consider the total shareholder return (TSR). Whereas the share price return only reflects the change in the share price, the TSR includes the value of dividends (assuming they were reinvested) and the benefit of any discounted capital raising or spin-off. So for companies that pay a generous dividend, the TSR is often a lot higher than the share price return. As it happens, Shanghai Lianming Machinery's TSR for the last 3 years was 50%, which exceeds the share price return mentioned earlier. And there's no prize for guessing that the dividend payments largely explain the divergence!

A Different Perspective

Shanghai Lianming Machinery shareholders are down 19% for the year (even including dividends), but the market itself is up 14%. Even the share prices of good stocks drop sometimes, but we want to see improvements in the fundamental metrics of a business, before getting too interested. Longer term investors wouldn't be so upset, since they would have made 8%, each year, over five years. It could be that the recent sell-off is an opportunity, so it may be worth checking the fundamental data for signs of a long term growth trend. I find it very interesting to look at share price over the long term as a proxy for business performance. But to truly gain insight, we need to consider other information, too. Take risks, for example - Shanghai Lianming Machinery has 2 warning signs we think you should be aware of.

If you would prefer to check out another company -- one with potentially superior financials -- then do not miss this free list of companies that have proven they can grow earnings.

Please note, the market returns quoted in this article reflect the market weighted average returns of stocks that currently trade on Chinese exchanges.

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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.