Does Chongqing Zongshen Power Machinery Co.,Ltd's (SZSE:001696) Weak Fundamentals Mean That The Market Could Correct Its Share Price?

Chongqing Zongshen Power MachineryLtd (SZSE:001696) has had a great run on the share market with its stock up by a significant 24% over the last month. 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. Specifically, we decided to study Chongqing Zongshen Power MachineryLtd's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. 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 Chongqing Zongshen Power MachineryLtd

How To Calculate Return On Equity?

Return on equity can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Chongqing Zongshen Power MachineryLtd is:

7.2% = CN¥384m ÷ CN¥5.4b (Based on the trailing twelve months to March 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¥0.07 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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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 7.2% ROE

At first glance, Chongqing Zongshen Power MachineryLtd's ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 8.2%. Having said that, Chongqing Zongshen Power MachineryLtd's five year net income decline rate was 3.9%. 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 8.9% in the same 5-year period.

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. Doing so will help them establish if the stock's future looks promising or ominous. Is Chongqing Zongshen Power MachineryLtd fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Chongqing Zongshen Power MachineryLtd Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 72% (implying that 28% of the profits are retained), most of Chongqing Zongshen Power MachineryLtd'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. To know the 2 risks we have identified for Chongqing Zongshen Power MachineryLtd visit our risks dashboard for free.

In addition, Chongqing Zongshen Power MachineryLtd has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Summary

On the whole, Chongqing Zongshen Power MachineryLtd's performance is quite a big let-down. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.