AA Industrial Belting (Shanghai) Co.,Ltd's (SHSE:603580) Stock Going Strong But Fundamentals Look Weak: What Implications Could This Have On The Stock?

AA Industrial Belting (Shanghai)Ltd's (SHSE:603580) stock is up by a considerable 10% over the past week. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. In this article, we decided to focus on AA Industrial Belting (Shanghai)Ltd'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for AA Industrial Belting (Shanghai)Ltd

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 AA Industrial Belting (Shanghai)Ltd is:

0.6% = CN¥2.9m ÷ CN¥450m (Based on the trailing twelve months to September 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¥0.01 in profit.

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.

A Side By Side comparison of AA Industrial Belting (Shanghai)Ltd's Earnings Growth And 0.6% ROE

It is hard to argue that AA Industrial Belting (Shanghai)Ltd's ROE is much good in and of itself. Even compared to the average industry ROE of 6.3%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 46% seen by AA Industrial Belting (Shanghai)Ltd was possibly a result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared AA Industrial Belting (Shanghai)Ltd's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 7.1% in the same period. This is quite worrisome.

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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about AA Industrial Belting (Shanghai)Ltd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is AA Industrial Belting (Shanghai)Ltd Efficiently Re-investing Its Profits?

With a three-year median payout ratio as high as 243%,AA Industrial Belting (Shanghai)Ltd's shrinking earnings don't come as a surprise as the company is paying a dividend which is beyond its means. Its usually very hard to sustain dividend payments that are higher than reported profits.

Moreover, AA Industrial Belting (Shanghai)Ltd has been paying dividends for seven years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking.

Conclusion

Overall, we would be extremely cautious before making any decision on AA Industrial Belting (Shanghai)Ltd. The low ROE, combined with the fact that the company is paying out almost if not all, of its profits as dividends, has resulted in the lack or absence of growth in its earnings. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. To gain further insights into AA Industrial Belting (Shanghai)Ltd's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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.