Can Mixed Fundamentals Have A Negative Impact on North Electro-Optic Co.,Ltd. (SHSE:600184) Current Share Price Momentum?

North Electro-OpticLtd's (SHSE:600184) stock is up by a considerable 11% over the past week. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on North Electro-OpticLtd's ROE.

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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for North Electro-OpticLtd

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 North Electro-OpticLtd is:

2.1% = CN¥53m ÷ CN¥2.5b (Based on the trailing twelve months to March 2024).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.02 in profit.

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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of North Electro-OpticLtd's Earnings Growth And 2.1% ROE

It is quite clear that North Electro-OpticLtd's ROE is rather low. Even when compared to the industry average of 5.0%, the ROE figure is pretty disappointing. Therefore, the disappointing ROE therefore provides a background to North Electro-OpticLtd's very little net income growth of 3.3% over the past five years.

As a next step, we compared North Electro-OpticLtd's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 10% in the same 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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about North Electro-OpticLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is North Electro-OpticLtd Efficiently Re-investing Its Profits?

Despite having a normal three-year median payout ratio of 41% (or a retention ratio of 59% over the past three years, North Electro-OpticLtd has seen very little growth in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Moreover, North Electro-OpticLtd has been paying dividends for eight years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Conclusion

In total, we're a bit ambivalent about North Electro-OpticLtd's performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. 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 1 risk we have identified for North Electro-OpticLtd 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com