Does The Market Have A Low Tolerance For Riyue Heavy Industry Co.,Ltd's (SHSE:603218) Mixed Fundamentals?

With its stock down 8.6% over the past month, it is easy to disregard Riyue Heavy IndustryLtd (SHSE:603218). 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. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. In this article, we decided to focus on Riyue Heavy IndustryLtd'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 Riyue Heavy IndustryLtd

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Riyue Heavy IndustryLtd is:

6.2% = CN¥629m ÷ CN¥10b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.06 in profit.

Why Is ROE Important For 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.

Riyue Heavy IndustryLtd's Earnings Growth And 6.2% ROE

At first glance, Riyue Heavy IndustryLtd's ROE doesn't look very promising. However, its ROE is similar to the industry average of 6.3%, so we won't completely dismiss the company. But then again, Riyue Heavy IndustryLtd's five year net income shrunk at a rate of 8.6%. Remember, the company's ROE is a bit low to begin with. Hence, this goes some way in explaining the shrinking earnings.

That being said, we compared Riyue Heavy IndustryLtd's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 7.4% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Riyue Heavy IndustryLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Riyue Heavy IndustryLtd Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 47% (where it is retaining 53% of its profits), Riyue Heavy IndustryLtd has seen a decline in earnings as we saw above. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

In addition, Riyue Heavy IndustryLtd has been paying dividends over a period of seven years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 54% of its profits over the next three years. Regardless, the future ROE for Riyue Heavy IndustryLtd is predicted to rise to 8.3% despite there being not much change expected in its payout ratio.

Conclusion

On the whole, we feel that the performance shown by Riyue Heavy IndustryLtd 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. 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. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.