Shanghai Karon Eco-Valve Manufacturing Co., Ltd.'s (SZSE:301151) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

Most readers would already be aware that Shanghai Karon Eco-Valve Manufacturing's (SZSE:301151) stock increased significantly by 25% over the past week. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Specifically, we decided to study Shanghai Karon Eco-Valve Manufacturing'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Shanghai Karon Eco-Valve Manufacturing

How Is ROE Calculated?

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 Shanghai Karon Eco-Valve Manufacturing is:

4.7% = CN¥99m ÷ CN¥2.1b (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.05 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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 Shanghai Karon Eco-Valve Manufacturing's Earnings Growth And 4.7% ROE

It is hard to argue that Shanghai Karon Eco-Valve Manufacturing's ROE is much good in and of itself. Even when compared to the industry average of 6.9%, the ROE figure is pretty disappointing. For this reason, Shanghai Karon Eco-Valve Manufacturing's five year net income decline of 15% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.

So, as a next step, we compared Shanghai Karon Eco-Valve Manufacturing's 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 9.6% over the last few years.

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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Shanghai Karon Eco-Valve Manufacturing's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shanghai Karon Eco-Valve Manufacturing Efficiently Re-investing Its Profits?

Despite having a normal three-year median payout ratio of 37% (where it is retaining 63% of its profits), Shanghai Karon Eco-Valve Manufacturing has seen a decline in earnings as we saw above. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, Shanghai Karon Eco-Valve Manufacturing started paying a dividend only recently. So it looks like the management may have perceived that shareholders favor dividends even though earnings have been in decline.

Conclusion

Overall, we have mixed feelings about Shanghai Karon Eco-Valve Manufacturing. 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. Our risks dashboard would have the 3 risks we have identified for Shanghai Karon Eco-Valve Manufacturing.

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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.