Is Shenzhen SED Industry Co., Ltd.'s (SZSE:000032) Recent Price Movement Underpinned By Its Weak Fundamentals?

With its stock down 22% over the past three months, it is easy to disregard Shenzhen SED Industry (SZSE:000032). It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. In this article, we decided to focus on Shenzhen SED Industry'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.

View our latest analysis for Shenzhen SED Industry

How Do You Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for Shenzhen SED Industry is:

7.5% = CN¥896m ÷ CN¥12b (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.07 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.

Shenzhen SED Industry's Earnings Growth And 7.5% ROE

At first glance, Shenzhen SED Industry's ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 7.3%, we may spare it some thought. But then again, Shenzhen SED Industry's five year net income shrunk at a rate of 15%. Remember, the company's ROE is a bit low to begin with. Therefore, the decline in earnings could also be the result of this.

So, as a next step, we compared Shenzhen SED Industry'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 7.8% over the last few years.

Earnings growth is an important metric to consider when valuing a stock. 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. If you're wondering about Shenzhen SED Industry's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shenzhen SED Industry Making Efficient Use Of Its Profits?

Looking at its three-year median payout ratio of 34% (or a retention ratio of 66%) which is pretty normal, Shenzhen SED Industry's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, Shenzhen SED Industry only recently started paying a dividend so the management probably decided the shareholders prefer dividends even though earnings have been shrinking. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 26% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.

Summary

In total, we're a bit ambivalent about Shenzhen SED Industry's 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. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.