Shenzhen Sine Electric Co.,Ltd. (SHSE:688395) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?

Shenzhen Sine ElectricLtd's (SHSE:688395) stock is up by a considerable 12% over the past week. 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. Particularly, we will be paying attention to Shenzhen Sine ElectricLtd's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Shenzhen Sine ElectricLtd

How Is ROE Calculated?

Return on equity 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 Shenzhen Sine ElectricLtd is:

5.5% = CN¥40m ÷ CN¥741m (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.05 in profit.

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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Shenzhen Sine ElectricLtd's Earnings Growth And 5.5% ROE

When you first look at it, Shenzhen Sine ElectricLtd's ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 6.9% either. Given the circumstances, the significant decline in net income by 5.0% seen by Shenzhen Sine ElectricLtd over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

So, as a next step, we compared Shenzhen Sine ElectricLtd'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 12% over the last few years.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. 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 Shenzhen Sine ElectricLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Shenzhen Sine ElectricLtd Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 30% (where it is retaining 70% of its profits), Shenzhen Sine ElectricLtd has seen a decline 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, Shenzhen Sine ElectricLtd 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.

Summary

Overall, we have mixed feelings about Shenzhen Sine ElectricLtd. 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. You can see the 3 risks we have identified for Shenzhen Sine ElectricLtd 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.