Shenzhen FRD Science & Technology Co., Ltd.'s (SZSE:300602) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

Most readers would already be aware that Shenzhen FRD Science & Technology's (SZSE:300602) stock increased significantly by 18% 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 FRD Science & Technology's ROE.

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.

Check out our latest analysis for Shenzhen FRD Science & Technology

How Do You 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 Shenzhen FRD Science & Technology is:

3.2% = CN¥123m ÷ CN¥3.8b (Based on the trailing twelve months to March 2024).

The 'return' is the profit over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.03 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

A Side By Side comparison of Shenzhen FRD Science & Technology's Earnings Growth And 3.2% ROE

As you can see, Shenzhen FRD Science & Technology's ROE looks pretty weak. Not just that, even compared to the industry average of 6.9%, the company's ROE is entirely unremarkable. Therefore, it might not be wrong to say that the five year net income decline of 30% seen by Shenzhen FRD Science & Technology 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. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared Shenzhen FRD Science & Technology's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 12% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 FRD Science & Technology is trading on a high P/E or a low P/E, relative to its industry.

Is Shenzhen FRD Science & Technology Using Its Retained Earnings Effectively?

Shenzhen FRD Science & Technology's low three-year median payout ratio of 13% (implying that it retains the remaining 87% of its profits) comes as a surprise when you pair it with the shrinking earnings. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.

Moreover, Shenzhen FRD Science & Technology has been paying dividends for seven 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.

Summary

In total, we're a bit ambivalent about Shenzhen FRD Science & Technology's performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.