Does The Market Have A Low Tolerance For Zhejiang Zhaofeng Mechanical and Electronic Co.,Ltd.'s (SZSE:300695) Mixed Fundamentals?

It is hard to get excited after looking at Zhejiang Zhaofeng Mechanical and ElectronicLtd's (SZSE:300695) recent performance, when its stock has declined 13% over the past month. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Specifically, we decided to study Zhejiang Zhaofeng Mechanical and ElectronicLtd's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Zhejiang Zhaofeng Mechanical and ElectronicLtd

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 Zhejiang Zhaofeng Mechanical and ElectronicLtd is:

5.4% = CN¥138m ÷ CN¥2.6b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.05 in profit.

What Has ROE Got To Do With 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. 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.

Zhejiang Zhaofeng Mechanical and ElectronicLtd's Earnings Growth And 5.4% ROE

When you first look at it, Zhejiang Zhaofeng Mechanical and ElectronicLtd's ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 8.3% either. Therefore, it might not be wrong to say that the five year net income decline of 4.8% seen by Zhejiang Zhaofeng Mechanical and ElectronicLtd was probably the result of it having a lower ROE. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.

However, when we compared Zhejiang Zhaofeng Mechanical and ElectronicLtd's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 9.2% in the same period. This is quite worrisome.

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. If you're wondering about Zhejiang Zhaofeng Mechanical and ElectronicLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Zhejiang Zhaofeng Mechanical and ElectronicLtd Efficiently Re-investing Its Profits?

Zhejiang Zhaofeng Mechanical and ElectronicLtd's low three-year median payout ratio of 9.4% (implying that it retains the remaining 91% of its profits) comes as a surprise when you pair it with the shrinking earnings. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, Zhejiang Zhaofeng Mechanical and ElectronicLtd has paid dividends over a period of seven years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Conclusion

On the whole, we feel that the performance shown by Zhejiang Zhaofeng Mechanical and ElectronicLtd can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. Our risks dashboard would have the 2 risks we have identified for Zhejiang Zhaofeng Mechanical and ElectronicLtd.

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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.