Guangdong Shenling Environmental Systems Co., Ltd.'s (SZSE:301018) Financials Are Too Obscure To Link With Current Share Price Momentum: What's In Store For the Stock?

Most readers would already be aware that Guangdong Shenling Environmental Systems' (SZSE:301018) stock increased significantly by 77% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. In this article, we decided to focus on Guangdong Shenling Environmental Systems' ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Guangdong Shenling Environmental Systems

How To Calculate Return On Equity?

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 Shenling Environmental Systems is:

3.5% = CN¥89m ÷ CN¥2.6b (Based on the trailing twelve months to September 2024).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.03 in profit.

What Has ROE Got To Do With 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 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 Guangdong Shenling Environmental Systems' Earnings Growth And 3.5% ROE

It is quite clear that Guangdong Shenling Environmental Systems' ROE is rather low. Even compared to the average industry ROE of 7.5%, the company's ROE is quite dismal. Therefore, Guangdong Shenling Environmental Systems' flat earnings over the past five years can possibly be explained by the low ROE amongst other factors.

We then compared Guangdong Shenling Environmental Systems' net income growth with the industry and found that the average industry growth rate was 3.5% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. 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 Guangdong Shenling Environmental Systems is trading on a high P/E or a low P/E, relative to its industry.

Is Guangdong Shenling Environmental Systems Making Efficient Use Of Its Profits?

In spite of a normal three-year median payout ratio of 33% (or a retention ratio of 67%), Guangdong Shenling Environmental Systems hasn't seen much growth in its earnings. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, Guangdong Shenling Environmental Systems has paid dividends over a period of three years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 30%. Regardless, the future ROE for Guangdong Shenling Environmental Systems is predicted to rise to 9.4% despite there being not much change expected in its payout ratio.

Summary

On the whole, we feel that the performance shown by Guangdong Shenling Environmental Systems can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.