Is The Market Rewarding Zhejiang Taifu Pump Co.,Ltd (SZSE:300992) With A Negative Sentiment As A Result Of Its Mixed Fundamentals?

With its stock down 20% over the past month, it is easy to disregard Zhejiang Taifu PumpLtd (SZSE:300992). We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Specifically, we decided to study Zhejiang Taifu PumpLtd'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 Zhejiang Taifu PumpLtd

How Do You 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 Zhejiang Taifu PumpLtd is:

6.6% = CN¥53m ÷ CN¥811m (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.07.

What Is The Relationship Between ROE And Earnings Growth?

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

Zhejiang Taifu PumpLtd's Earnings Growth And 6.6% ROE

When you first look at it, Zhejiang Taifu PumpLtd's ROE doesn't look that attractive. However, its ROE is similar to the industry average of 6.8%, so we won't completely dismiss the company. But Zhejiang Taifu PumpLtd saw a five year net income decline of 9.5% over the past five years. Remember, the company's ROE is a bit low to begin with. Hence, this goes some way in explaining the shrinking earnings.

That being said, we compared Zhejiang Taifu PumpLtd's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 9.4% in the same 5-year period.

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. If you're wondering about Zhejiang Taifu PumpLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Zhejiang Taifu PumpLtd Making Efficient Use Of Its Profits?

Zhejiang Taifu PumpLtd's low three-year median payout ratio of 11% (or a retention ratio of 89%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. 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.

Only recently, Zhejiang Taifu PumpLtd stated paying a dividend. This likely means that the management might have concluded that its shareholders have a strong preference for dividends.

Conclusion

On the whole, we feel that the performance shown by Zhejiang Taifu PumpLtd can be open to many interpretations. 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. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. You can see the 2 risks we have identified for Zhejiang Taifu PumpLtd by visiting our risks dashboard for free on our platform here.

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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.