Leader Harmonious Drive Systems Co., Ltd. (SHSE:688017) Is Going Strong But Fundamentals Appear To Be Mixed : Is There A Clear Direction For The Stock?

Most readers would already be aware that Leader Harmonious Drive Systems' (SHSE:688017) stock increased significantly by 64% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Particularly, we will be paying attention to Leader Harmonious Drive Systems' 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Leader Harmonious Drive Systems

How To Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Leader Harmonious Drive Systems is:

3.5% = CN¥71m ÷ CN¥2.0b (Based on the trailing twelve months to September 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¥0.03 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. 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. 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.

Leader Harmonious Drive Systems' Earnings Growth And 3.5% ROE

It is quite clear that Leader Harmonious Drive Systems' ROE is rather low. Even compared to the average industry ROE of 6.3%, the company's ROE is quite dismal. Hence, the flat earnings seen by Leader Harmonious Drive Systems over the past five years could probably be the result of it having a lower ROE.

We then compared Leader Harmonious Drive Systems' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 7.4% in the same 5-year period, which is a bit concerning.

Earnings growth is a huge factor in stock valuation. 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 Leader Harmonious Drive Systems is trading on a high P/E or a low P/E, relative to its industry.

Is Leader Harmonious Drive Systems Efficiently Re-investing Its Profits?

Despite having a normal three-year median payout ratio of 41% (implying that the company keeps 59% of its income) over the last three years, Leader Harmonious Drive Systems has seen a negligible amount of growth in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

In addition, Leader Harmonious Drive Systems has been paying dividends over a period of four years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. 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 36%. Regardless, the future ROE for Leader Harmonious Drive Systems is predicted to rise to 7.3% despite there being not much change expected in its payout ratio.

Conclusion

On the whole, we feel that the performance shown by Leader Harmonious Drive Systems 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. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.