Is Essence Fastening Systems (Shanghai) Co., Ltd.'s (SZSE:301005) Recent Price Movement Underpinned By Its Weak Fundamentals?

It is hard to get excited after looking at Essence Fastening Systems (Shanghai)'s (SZSE:301005) recent performance, when its stock has declined 11% over the past week. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on Essence Fastening Systems (Shanghai)'s ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Essence Fastening Systems (Shanghai)

How Is ROE Calculated?

ROE 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 Essence Fastening Systems (Shanghai) is:

1.8% = CN¥15m ÷ CN¥832m (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.02.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Essence Fastening Systems (Shanghai)'s Earnings Growth And 1.8% ROE

It is quite clear that Essence Fastening Systems (Shanghai)'s ROE is rather low. Not just that, even compared to the industry average of 8.1%, the company's ROE is entirely unremarkable. For this reason, Essence Fastening Systems (Shanghai)'s five year net income decline of 7.3% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

So, as a next step, we compared Essence Fastening Systems (Shanghai)'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 8.4% over the last few years.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Essence Fastening Systems (Shanghai)'s's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Essence Fastening Systems (Shanghai) Efficiently Re-investing Its Profits?

Looking at its three-year median payout ratio of 48% (or a retention ratio of 52%) which is pretty normal, Essence Fastening Systems (Shanghai)'s declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

In addition, Essence Fastening Systems (Shanghai) has been paying dividends over a period of three years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.

Summary

On the whole, we feel that the performance shown by Essence Fastening Systems (Shanghai) 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. To know the 3 risks we have identified for Essence Fastening Systems (Shanghai) visit our risks dashboard for free.

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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.