Nanxing Machinery Co., Ltd.'s (SZSE:002757) Has Been On A Rise But Financial Prospects Look Weak: Is The Stock Overpriced?

Nanxing Machinery's (SZSE:002757) stock is up by a considerable 42% over the past three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Specifically, we decided to study Nanxing Machinery's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Nanxing Machinery

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 Nanxing Machinery is:

6.2% = CN¥149m ÷ CN¥2.4b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.06.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Nanxing Machinery's Earnings Growth And 6.2% ROE

At first glance, Nanxing Machinery's ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 6.3%. However, Nanxing Machinery has seen a flattish net income growth over the past five years, which is not saying much. Bear in mind, the company's ROE is not very high. So that could also be one of the reasons behind the company's flat growth in earnings.

Next, on comparing with the industry net income growth, we found that the industry grew its earnings by 7.3% over the last few years.

Earnings growth is an important metric to consider when valuing a stock. 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 Nanxing Machinery is trading on a high P/E or a low P/E, relative to its industry.

Is Nanxing Machinery Using Its Retained Earnings Effectively?

Nanxing Machinery has a high three-year median payout ratio of 61% (or a retention ratio of 39%), meaning that the company is paying most of its profits as dividends to its shareholders. This does go some way in explaining why there's been no growth in its earnings.

In addition, Nanxing Machinery has been paying dividends over a period of nine years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Summary

In total, we would have a hard think before deciding on any investment action concerning Nanxing Machinery. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. So far, we've only made a quick discussion around the company's earnings growth. So it may be worth checking this free detailed graph of Nanxing Machinery's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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

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.