Is Fujian Longking Co., Ltd.'s (SHSE:600388) Recent Price Movement Underpinned By Its Weak Fundamentals?

Fujian Longking (SHSE:600388) has had a rough month with its share price down 11%. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Particularly, we will be paying attention to Fujian Longking's ROE today.

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.

See our latest analysis for Fujian Longking

How Is ROE Calculated?

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 Fujian Longking is:

6.4% = CN¥520m ÷ CN¥8.1b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.06.

Why Is ROE Important For 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.

Fujian Longking's Earnings Growth And 6.4% ROE

When you first look at it, Fujian Longking's ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 6.8%, we may spare it some thought. Having said that, Fujian Longking's five year net income decline rate was 3.5%. Bear in mind, the company does have a slightly low ROE. So that's what might be causing earnings growth to shrink.

So, as a next step, we compared Fujian Longking'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 9.4% over the last few years.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Has the market priced in the future outlook for 600388? You can find out in our latest intrinsic value infographic research report.

Is Fujian Longking Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 32% (that is, a retention ratio of 68%), the fact that Fujian Longking's earnings have shrunk is quite puzzling. 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, Fujian Longking 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

Overall, we have mixed feelings about Fujian Longking. 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. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.