Shenzhen Zhaowei Machinery & Electronics Co., Ltd.'s (SZSE:003021) Stock is Soaring But Financials Seem Inconsistent: Will The Uptrend Continue?

Shenzhen Zhaowei Machinery & Electronics' (SZSE:003021) stock is up by a considerable 85% over the past 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. In this article, we decided to focus on Shenzhen Zhaowei Machinery & Electronics' 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Shenzhen Zhaowei Machinery & Electronics

How To 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 Zhaowei Machinery & Electronics is:

6.7% = CN¥211m ÷ CN¥3.2b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.07 in profit.

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.

Shenzhen Zhaowei Machinery & Electronics' Earnings Growth And 6.7% ROE

When you first look at it, Shenzhen Zhaowei Machinery & Electronics' ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 6.4%, we may spare it some thought. But then again, Shenzhen Zhaowei Machinery & Electronics' five year net income shrunk at a rate of 12%. Remember, the company's ROE is a bit low to begin with. Hence, this goes some way in explaining the shrinking earnings.

So, as a next step, we compared Shenzhen Zhaowei Machinery & Electronics' 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 10% 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. Is Shenzhen Zhaowei Machinery & Electronics fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Shenzhen Zhaowei Machinery & Electronics Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 29% (that is, a retention ratio of 71%), the fact that Shenzhen Zhaowei Machinery & Electronics' earnings have shrunk is quite puzzling. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

In addition, Shenzhen Zhaowei Machinery & Electronics has been paying dividends over a period of four years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.

Conclusion

Overall, we have mixed feelings about Shenzhen Zhaowei Machinery & Electronics. 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. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.