Chongqing Zongshen Power Machinery Co.,Ltd's (SZSE:001696) Stock Going Strong But Fundamentals Look Weak: What Implications Could This Have On The Stock?

Chongqing Zongshen Power MachineryLtd (SZSE:001696) has had a great run on the share market with its stock up by a significant 141% over the last three months. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. Particularly, we will be paying attention to Chongqing Zongshen Power MachineryLtd's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Chongqing Zongshen Power MachineryLtd

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 Chongqing Zongshen Power MachineryLtd is:

7.5% = CN¥400m ÷ CN¥5.4b (Based on the trailing twelve months to September 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.07 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 Chongqing Zongshen Power MachineryLtd's Earnings Growth And 7.5% ROE

On the face of it, Chongqing Zongshen Power MachineryLtd's ROE is not much to talk about. However, given that the company's ROE is similar to the average industry ROE of 8.2%, we may spare it some thought. But Chongqing Zongshen Power MachineryLtd saw a five year net income decline of 6.9% over the past five years. Remember, the company's ROE is a bit low to begin with. So that's what might be causing earnings growth to shrink.

That being said, we compared Chongqing Zongshen Power MachineryLtd's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 9.0% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Chongqing Zongshen Power MachineryLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Chongqing Zongshen Power MachineryLtd Using Its Retained Earnings Effectively?

Chongqing Zongshen Power MachineryLtd's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 74% (or a retention ratio of 26%). 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. To know the 2 risks we have identified for Chongqing Zongshen Power MachineryLtd visit our risks dashboard for free.

Additionally, Chongqing Zongshen Power MachineryLtd has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Summary

In total, we would have a hard think before deciding on any investment action concerning Chongqing Zongshen Power MachineryLtd. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.