Should Weakness in Changchai Company, Limited's (SZSE:000570) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

With its stock down 16% over the past month, it is easy to disregard Changchai Company (SZSE:000570). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Changchai Company's 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Changchai Company

How To 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 Changchai Company is:

3.5% = CN¥123m ÷ CN¥3.5b (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.03 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. 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.

Changchai Company's Earnings Growth And 3.5% ROE

It is hard to argue that Changchai Company's ROE is much good in and of itself. Even when compared to the industry average of 6.8%, the ROE figure is pretty disappointing. In spite of this, Changchai Company was able to grow its net income considerably, at a rate of 22% in the last five years. We reckon that there could be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

Next, on comparing with the industry net income growth, we found that Changchai Company's growth is quite high when compared to the industry average growth of 9.4% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Is Changchai Company fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Changchai Company Using Its Retained Earnings Effectively?

Changchai Company has a really low three-year median payout ratio of 11%, meaning that it has the remaining 89% left over to reinvest into its business. So it looks like Changchai Company is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Moreover, Changchai Company is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Summary

In total, it does look like Changchai Company has some positive aspects to its business. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard would have the 2 risks we have identified for Changchai 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.