Does Guangzhou Tongda Auto Electric Co., Ltd's (SHSE:603390) Weak Fundamentals Mean That The Market Could Correct Its Share Price?

Most readers would already be aware that Guangzhou Tongda Auto Electric's (SHSE:603390) stock increased significantly by 12% 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. In this article, we decided to focus on Guangzhou Tongda Auto Electric's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Guangzhou Tongda Auto Electric

How To 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 Guangzhou Tongda Auto Electric is:

2.3% = CN¥36m ÷ CN¥1.6b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.02 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 Guangzhou Tongda Auto Electric's Earnings Growth And 2.3% ROE

It is quite clear that Guangzhou Tongda Auto Electric's ROE is rather low. Even when compared to the industry average of 8.3%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 48% seen by Guangzhou Tongda Auto Electric over the last five years is not surprising. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.

So, as a next step, we compared Guangzhou Tongda Auto Electric's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 9.2% over the last few years.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is Guangzhou Tongda Auto Electric fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Guangzhou Tongda Auto Electric Using Its Retained Earnings Effectively?

Guangzhou Tongda Auto Electric has a high three-year median payout ratio of 83% (that is, it is retaining 17% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only very little left to reinvest into the business, growth in earnings is far from likely. Our risks dashboard should have the 3 risks we have identified for Guangzhou Tongda Auto Electric.

Moreover, Guangzhou Tongda Auto Electric has been paying dividends for five years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking.

Summary

Overall, we would be extremely cautious before making any decision on Guangzhou Tongda Auto Electric. 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. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. You can do your own research on Guangzhou Tongda Auto Electric 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.