Shenzhen Cheng Chung Design Co., Ltd.'s (SZSE:002811) Has Been On A Rise But Financial Prospects Look Weak: Is The Stock Overpriced?

Shenzhen Cheng Chung Design (SZSE:002811) has had a great run on the share market with its stock up by a significant 11% over the last week. 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 Shenzhen Cheng Chung Design's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Shenzhen Cheng Chung Design

How To Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Shenzhen Cheng Chung Design is:

0.7% = CN¥7.6m ÷ CN¥1.1b (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.01.

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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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 Shenzhen Cheng Chung Design's Earnings Growth And 0.7% ROE

It is hard to argue that Shenzhen Cheng Chung Design's ROE is much good in and of itself. Not just that, even compared to the industry average of 6.8%, the company's ROE is entirely unremarkable. Therefore, it might not be wrong to say that the five year net income decline of 65% seen by Shenzhen Cheng Chung Design was possibly a result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.

However, when we compared Shenzhen Cheng Chung Design's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 7.0% 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. This then helps them determine if the stock is placed for a bright or bleak future. 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 Shenzhen Cheng Chung Design is trading on a high P/E or a low P/E, relative to its industry.

Is Shenzhen Cheng Chung Design Efficiently Re-investing Its Profits?

Shenzhen Cheng Chung Design's high three-year median payout ratio of 364% suggests that the company is depleting its resources to keep up its dividend payments, and this shows in its shrinking earnings. Paying a dividend beyond their means is usually not viable over the long term. Our risks dashboard should have the 2 risks we have identified for Shenzhen Cheng Chung Design.

In addition, Shenzhen Cheng Chung Design has been paying dividends over a period of seven years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.

Summary

On the whole, Shenzhen Cheng Chung Design's performance is quite a big let-down. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. You can do your own research on Shenzhen Cheng Chung Design and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.

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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.