Guangdong KinLong Hardware Products Co.,Ltd.'s (SZSE:002791) Stock is Soaring But Financials Seem Inconsistent: Will The Uptrend Continue?

Guangdong KinLong Hardware ProductsLtd (SZSE:002791) has had a great run on the share market with its stock up by a significant 43% over the last three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Particularly, we will be paying attention to Guangdong KinLong Hardware ProductsLtd's ROE today.

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.

See our latest analysis for Guangdong KinLong Hardware ProductsLtd

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 Guangdong KinLong Hardware ProductsLtd is:

4.0% = CN¥241m ÷ CN¥6.0b (Based on the trailing twelve months to September 2024).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.04 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. 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.

Guangdong KinLong Hardware ProductsLtd's Earnings Growth And 4.0% ROE

As you can see, Guangdong KinLong Hardware ProductsLtd's ROE looks pretty weak. Even when compared to the industry average of 7.5%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 20% seen by Guangdong KinLong Hardware ProductsLtd over the last five years is not surprising. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared Guangdong KinLong Hardware ProductsLtd's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 3.5% in the same period. This is quite worrisome.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Guangdong KinLong Hardware ProductsLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Guangdong KinLong Hardware ProductsLtd Efficiently Re-investing Its Profits?

Guangdong KinLong Hardware ProductsLtd's low three-year median payout ratio of 15% (implying that it retains the remaining 85% of its profits) comes as a surprise when you pair it with the shrinking earnings. This typically shouldn't be the case when a company is retaining most of its earnings. So there could be some other explanations in that regard. For example, the company's business may be deteriorating.

Moreover, Guangdong KinLong Hardware ProductsLtd has been paying dividends for nine years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent 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 12% over the next three years. As a result, the expected drop in Guangdong KinLong Hardware ProductsLtd's payout ratio explains the anticipated rise in the company's future ROE to 7.2%, over the same period.

Conclusion

In total, we're a bit ambivalent about Guangdong KinLong Hardware ProductsLtd's performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.