Has Shanghai Mechanical & Electrical Industry Co.,Ltd.'s (SHSE:600835) Impressive Stock Performance Got Anything to Do With Its Fundamentals?

Most readers would already be aware that Shanghai Mechanical & Electrical IndustryLtd's (SHSE:600835) stock increased significantly by 63% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Specifically, we decided to study Shanghai Mechanical & Electrical IndustryLtd's ROE in this article.

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 Shanghai Mechanical & Electrical IndustryLtd

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 Shanghai Mechanical & Electrical IndustryLtd is:

8.6% = CN¥1.4b ÷ CN¥16b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.09 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. 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 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.

Shanghai Mechanical & Electrical IndustryLtd's Earnings Growth And 8.6% ROE

On the face of it, Shanghai Mechanical & Electrical IndustryLtd's ROE is not much to talk about. However, the fact that the its ROE is quite higher to the industry average of 6.3% doesn't go unnoticed by us. But seeing Shanghai Mechanical & Electrical IndustryLtd's five year net income decline of 4.1% over the past five years, we might rethink that. Bear in mind, the company does have a slightly low ROE. It is just that the industry ROE is lower. So that could be one of the factors that are causing earnings growth to shrink.

However, when we compared Shanghai Mechanical & Electrical IndustryLtd's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 7.4% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. 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 Shanghai Mechanical & Electrical IndustryLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Shanghai Mechanical & Electrical IndustryLtd Efficiently Re-investing Its Profits?

Looking at its three-year median payout ratio of 45% (or a retention ratio of 55%) which is pretty normal, Shanghai Mechanical & Electrical IndustryLtd'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.

Moreover, Shanghai Mechanical & Electrical IndustryLtd 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, it does look like Shanghai Mechanical & Electrical IndustryLtd has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a moderate ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.