Shanghai Kelai Mechatronics Engineering Co.,Ltd.'s (SHSE:603960) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

Shanghai Kelai Mechatronics EngineeringLtd (SHSE:603960) has had a rough three months with its share price down 38%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Shanghai Kelai Mechatronics EngineeringLtd'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Shanghai Kelai Mechatronics EngineeringLtd

How Do You 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 Shanghai Kelai Mechatronics EngineeringLtd is:

8.3% = CN¥91m ÷ CN¥1.1b (Based on the trailing twelve months to March 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¥0.08 in profit.

What Is The Relationship Between ROE And 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 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.

Shanghai Kelai Mechatronics EngineeringLtd's Earnings Growth And 8.3% ROE

At first glance, Shanghai Kelai Mechatronics EngineeringLtd's ROE doesn't look very promising. Although a closer study shows that the company's ROE is higher than the industry average of 6.8% which we definitely can't overlook. But seeing Shanghai Kelai Mechatronics EngineeringLtd's five year net income decline of 8.2% over the past five years, we might rethink that. Remember, the company's ROE is a bit low to begin with, just that it is higher than the industry average. So that could be one of the factors that are causing earnings growth to shrink.

However, when we compared Shanghai Kelai Mechatronics EngineeringLtd's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 9.4% in the same period. This is quite worrisome.

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. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for 603960? You can find out in our latest intrinsic value infographic research report.

Is Shanghai Kelai Mechatronics EngineeringLtd Using Its Retained Earnings Effectively?

Looking at its three-year median payout ratio of 31% (or a retention ratio of 69%) which is pretty normal, Shanghai Kelai Mechatronics EngineeringLtd'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 could be some other explanations in that regard. For instance, the company's business may be deteriorating.

In addition, Shanghai Kelai Mechatronics EngineeringLtd 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.

Summary

In total, it does look like Shanghai Kelai Mechatronics EngineeringLtd has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a respectable rate of return and is reinvesting a huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing 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 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.