Jiangxi Hongdu Aviation Industry Co., Ltd.'s (SHSE:600316) Stock is Soaring But Financials Seem Inconsistent: Will The Uptrend Continue?

Most readers would already be aware that Jiangxi Hongdu Aviation Industry's (SHSE:600316) stock increased significantly by 61% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to Jiangxi Hongdu Aviation Industry's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Jiangxi Hongdu Aviation Industry

How Do You 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 Jiangxi Hongdu Aviation Industry is:

0.7% = CN¥38m ÷ CN¥5.3b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.01 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. 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.

Jiangxi Hongdu Aviation Industry's Earnings Growth And 0.7% ROE

As you can see, Jiangxi Hongdu Aviation Industry's ROE looks pretty weak. Even compared to the average industry ROE of 5.0%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 16% seen by Jiangxi Hongdu Aviation Industry was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

So, as a next step, we compared Jiangxi Hongdu Aviation Industry'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 13% over the last few years.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Jiangxi Hongdu Aviation Industry is trading on a high P/E or a low P/E, relative to its industry.

Is Jiangxi Hongdu Aviation Industry Making Efficient Use Of Its Profits?

Looking at its three-year median payout ratio of 33% (or a retention ratio of 67%) which is pretty normal, Jiangxi Hongdu Aviation Industry'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. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, Jiangxi Hongdu Aviation Industry 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.

Conclusion

In total, we're a bit ambivalent about Jiangxi Hongdu Aviation Industry'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. Our risks dashboard would have the 3 risks we have identified for Jiangxi Hongdu Aviation Industry.

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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.