JiangSu Changling Hydraulic Co.,Ltd (SHSE:605389) Is Going Strong But Fundamentals Appear To Be Mixed : Is There A Clear Direction For The Stock?

JiangSu Changling HydraulicLtd (SHSE:605389) has had a great run on the share market with its stock up by a significant 41% over the last three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. In this article, we decided to focus on JiangSu Changling HydraulicLtd's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for JiangSu Changling HydraulicLtd

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 JiangSu Changling HydraulicLtd is:

6.0% = CN¥129m ÷ CN¥2.2b (Based on the trailing twelve months to September 2024).

The 'return' is the profit over the last twelve months. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.06.

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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

JiangSu Changling HydraulicLtd's Earnings Growth And 6.0% ROE

At first glance, JiangSu Changling HydraulicLtd's ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 6.3%. But then again, JiangSu Changling HydraulicLtd's five year net income shrunk at a rate of 21%. Bear in mind, the company does have a slightly low ROE. Therefore, the decline in earnings could also be the result of this.

So, as a next step, we compared JiangSu Changling HydraulicLtd's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 7.4% over the last few years.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 JiangSu Changling HydraulicLtd is trading on a high P/E or a low P/E, relative to its industry.

Is JiangSu Changling HydraulicLtd Making Efficient Use Of Its Profits?

Looking at its three-year median payout ratio of 43% (or a retention ratio of 57%) which is pretty normal, JiangSu Changling HydraulicLtd'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. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, JiangSu Changling HydraulicLtd has been paying dividends for four 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.

Summary

On the whole, we feel that the performance shown by JiangSu Changling HydraulicLtd can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. To know the 2 risks we have identified for JiangSu Changling HydraulicLtd visit our risks dashboard for free.

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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.