Can Mixed Fundamentals Have A Negative Impact on China Railway High-speed Electrification Equipment Corporation Limited (SHSE:688285) Current Share Price Momentum?

China Railway High-speed Electrification Equipment (SHSE:688285) has had a great run on the share market with its stock up by a significant 12% over the last week. 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. In this article, we decided to focus on China Railway High-speed Electrification Equipment's ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for China Railway High-speed Electrification Equipment

How Is ROE Calculated?

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 China Railway High-speed Electrification Equipment is:

2.2% = CN¥37m ÷ CN¥1.6b (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.02 in profit.

What Has ROE Got To Do With 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 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.

A Side By Side comparison of China Railway High-speed Electrification Equipment's Earnings Growth And 2.2% ROE

As you can see, China Railway High-speed Electrification Equipment's ROE looks pretty weak. Not just that, even compared to the industry average of 7.0%, the company's ROE is entirely unremarkable. Given the circumstances, the significant decline in net income by 12% seen by China Railway High-speed Electrification Equipment over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

That being said, we compared China Railway High-speed Electrification Equipment'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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about China Railway High-speed Electrification Equipment's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is China Railway High-speed Electrification Equipment Making Efficient Use Of Its Profits?

China Railway High-speed Electrification Equipment's low three-year median payout ratio of 22% (implying that it retains the remaining 78% of its profits) comes as a surprise when you pair it with the shrinking earnings. This typically shouldn't be the case when a company is retaining most of its earnings. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.

Only recently, China Railway High-speed Electrification Equipment stated paying a dividend. This likely means that the management might have concluded that its shareholders have a strong preference for dividends.

Summary

On the whole, we feel that the performance shown by China Railway High-speed Electrification Equipment can be open to many interpretations. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. 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. You can see the 3 risks we have identified for China Railway High-speed Electrification Equipment by visiting our risks dashboard for free on our platform here.

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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.