Leader Harmonious Drive Systems Co., Ltd. (SHSE:688017) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?

Leader Harmonious Drive Systems (SHSE:688017) has had a great run on the share market with its stock up by a significant 45% over the last month. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. In this article, we decided to focus on Leader Harmonious Drive Systems' ROE.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Leader Harmonious Drive Systems

How Do You 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 Leader Harmonious Drive Systems is:

3.5% = CN¥71m ÷ CN¥2.0b (Based on the trailing twelve months to June 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¥0.04 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

Leader Harmonious Drive Systems' Earnings Growth And 3.5% ROE

As you can see, Leader Harmonious Drive Systems' ROE looks pretty weak. Even when compared to the industry average of 6.9%, the ROE figure is pretty disappointing. Thus, the low net income growth of 4.5% 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 8.7% 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?

While Leader Harmonious Drive Systems has a decent three-year median payout ratio of 40% (or a retention ratio of 60%), it has seen very little growth in earnings. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, Leader Harmonious Drive Systems has paid dividends over a period of three years, which means that the company's management is determined to pay dividends even if it means little to no earnings 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 43%. However, Leader Harmonious Drive Systems' ROE is predicted to rise to 7.5% despite there being no anticipated change in its payout ratio.

Summary

In total, we're a bit ambivalent about Leader Harmonious Drive Systems' performance. 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 latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.