Xuchang Yuandong Drive Shaft Co.Ltd's (SZSE:002406) Dismal Stock Performance Reflects Weak Fundamentals

Xuchang Yuandong Drive ShaftLtd (SZSE:002406) has had a rough three months with its share price down 20%. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. Particularly, we will be paying attention to Xuchang Yuandong Drive ShaftLtd'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 Xuchang Yuandong Drive ShaftLtd

How Do You Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Xuchang Yuandong Drive ShaftLtd is:

2.5% = CN¥102m ÷ CN¥4.0b (Based on the trailing twelve months to March 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?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

A Side By Side comparison of Xuchang Yuandong Drive ShaftLtd's Earnings Growth And 2.5% ROE

As you can see, Xuchang Yuandong Drive ShaftLtd's ROE looks pretty weak. Even when compared to the industry average of 8.1%, the ROE figure is pretty disappointing. Therefore, it might not be wrong to say that the five year net income decline of 27% seen by Xuchang Yuandong Drive ShaftLtd was possibly a result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

That being said, we compared Xuchang Yuandong Drive ShaftLtd'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 8.4% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. 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 Xuchang Yuandong Drive ShaftLtd fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Xuchang Yuandong Drive ShaftLtd Making Efficient Use Of Its Profits?

Xuchang Yuandong Drive ShaftLtd'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 58% (or a retention ratio of 42%). 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 Xuchang Yuandong Drive ShaftLtd by visiting our risks dashboard for free on our platform here.

Moreover, Xuchang Yuandong Drive ShaftLtd 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

Overall, we would be extremely cautious before making any decision on Xuchang Yuandong Drive ShaftLtd. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. Up till now, we've only made a short study of the company's growth data. To gain further insights into Xuchang Yuandong Drive ShaftLtd's past profit growth, check out this visualization 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.