Xianheng International Science&Technology Co., Ltd.'s (SHSE:605056) Has Been On A Rise But Financial Prospects Look Weak: Is The Stock Overpriced?

Xianheng International Science&Technology (SHSE:605056) has had a great run on the share market with its stock up by a significant 17% over the last 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. Particularly, we will be paying attention to Xianheng International Science&Technology's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Xianheng International Science&Technology

How To Calculate Return On Equity?

ROE can be calculated by using the formula:

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

So, based on the above formula, the ROE for Xianheng International Science&Technology is:

7.4% = CN¥116m ÷ CN¥1.6b (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.07.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of Xianheng International Science&Technology's Earnings Growth And 7.4% ROE

When you first look at it, Xianheng International Science&Technology's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.0%. Having said that, Xianheng International Science&Technology's five year net income decline rate was 18%. Remember, the company's ROE is a bit low to begin with. So that's what might be causing earnings growth to shrink.

That being said, we compared Xianheng International Science&Technology'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 8.8% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Xianheng International Science&Technology is trading on a high P/E or a low P/E, relative to its industry.

Is Xianheng International Science&Technology Efficiently Re-investing Its Profits?

Xianheng International Science&Technology has a high three-year median payout ratio of 70% (that is, it is retaining 30% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. To know the 3 risks we have identified for Xianheng International Science&Technology visit our risks dashboard for free.

In addition, Xianheng International Science&Technology has been paying dividends over a period of three years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 61%. However, Xianheng International Science&Technology's ROE is predicted to rise to 17% despite there being no anticipated change in its payout ratio.

Summary

In total, we would have a hard think before deciding on any investment action concerning Xianheng International Science&Technology. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.