Shanghai Lianming Machinery Co., Ltd.'s (SHSE:603006) Dismal Stock Performance Reflects Weak Fundamentals

With its stock down 18% over the past month, it is easy to disregard Shanghai Lianming Machinery (SHSE:603006). To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. Particularly, we will be paying attention to Shanghai Lianming Machinery's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Shanghai Lianming Machinery

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 Shanghai Lianming Machinery is:

2.5% = CN¥43m ÷ CN¥1.7b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.03 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. 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 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.

Shanghai Lianming Machinery's Earnings Growth And 2.5% ROE

It is quite clear that Shanghai Lianming Machinery's ROE is rather low. Even when compared to the industry average of 8.3%, the ROE figure is pretty disappointing. Accordingly, Shanghai Lianming Machinery's low net income growth of 2.1% over the past five years can possibly be explained by the low ROE amongst other factors.

As a next step, we compared Shanghai Lianming Machinery's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 9.2% in the same period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. 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 Lianming Machinery is trading on a high P/E or a low P/E, relative to its industry.

Is Shanghai Lianming Machinery Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 70% (or a retention ratio of 30%), most of Shanghai Lianming Machinery's profits are being paid to shareholders. This definitely contributes to the low earnings growth seen by the company.

Moreover, Shanghai Lianming Machinery 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.

Summary

In total, we would have a hard think before deciding on any investment action concerning Shanghai Lianming Machinery. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. In brief, we think the company is risky and investors should think twice before making any final judgement on this company. To know the 2 risks we have identified for Shanghai Lianming Machinery 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.