Should Weakness in China Railway Construction Heavy Industry Corporation Limited's (SHSE:688425) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

It is hard to get excited after looking at China Railway Construction Heavy Industry's (SHSE:688425) recent performance, when its stock has declined 7.1% over the past three months. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to China Railway Construction Heavy Industry's ROE today.

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 China Railway Construction Heavy Industry

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for China Railway Construction Heavy Industry is:

9.1% = CN¥1.5b ÷ CN¥17b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.09 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

A Side By Side comparison of China Railway Construction Heavy Industry's Earnings Growth And 9.1% ROE

When you first look at it, China Railway Construction Heavy Industry's ROE doesn't look that attractive. However, the fact that the its ROE is quite higher to the industry average of 6.8% doesn't go unnoticed by us. However, China Railway Construction Heavy Industry has seen a flattish net income growth over the past five years, which is not saying much. Remember, the company's ROE is a bit low to begin with, just that it is higher than the industry average. Therefore, the low to flat growth in earnings could also be the result of this.

As a next step, we compared China Railway Construction Heavy Industry's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 9.5% in the same period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 China Railway Construction Heavy Industry is trading on a high P/E or a low P/E, relative to its industry.

Is China Railway Construction Heavy Industry Making Efficient Use Of Its Profits?

Despite having a normal three-year median payout ratio of 29% (implying that the company keeps 71% of its income) over the last three years, China Railway Construction Heavy Industry has seen a negligible amount of growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, China Railway Construction Heavy Industry started paying a dividend only recently. So it looks like the management must have perceived that shareholders favor dividends over earnings growth.

Summary

On the whole, we do feel that China Railway Construction Heavy Industry has some positive attributes. However, while the company does have a decent ROE and a high profit retention, its earnings growth number is quite disappointing. This suggests that there might be some external threat to the business, that's hampering growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.

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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.

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