Can Shanghai Carthane Co.,Ltd.'s (SHSE:603037) Weak Financials Pull The Plug On The Stock's Current Momentum On Its Share Price?

Shanghai CarthaneLtd's (SHSE:603037) stock is up by a considerable 20% over the past week. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. Particularly, we will be paying attention to Shanghai CarthaneLtd'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Shanghai CarthaneLtd

How Do You Calculate Return On Equity?

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 CarthaneLtd is:

7.2% = CN¥63m ÷ CN¥877m (Based on the trailing twelve months to September 2023).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.07 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 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 CarthaneLtd's Earnings Growth And 7.2% ROE

At first glance, Shanghai CarthaneLtd's ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.7%. Having said that, Shanghai CarthaneLtd's five year net income decline rate was 8.5%. Remember, the company's ROE is a bit low to begin with. Hence, this goes some way in explaining the shrinking earnings.

However, when we compared Shanghai CarthaneLtd's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 6.4% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. 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 CarthaneLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Shanghai CarthaneLtd Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 77% (implying that 23% of the profits are retained), most of Shanghai CarthaneLtd's profits are being paid to shareholders, which explains the company's shrinking earnings. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. You can see the 4 risks we have identified for Shanghai CarthaneLtd by visiting our risks dashboard for free on our platform here.

In addition, Shanghai CarthaneLtd 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

On the whole, Shanghai CarthaneLtd's performance is quite a big let-down. 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. So far, we've only made a quick discussion around the company's earnings growth. You can do your own research on Shanghai CarthaneLtd and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.

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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.