Changzhou Xiangming Intelligent Drive System Corporation's (SZSE:301226) Stock Going Strong But Fundamentals Look Weak: What Implications Could This Have On The Stock?

Changzhou Xiangming Intelligent Drive System (SZSE:301226) has had a great run on the share market with its stock up by a significant 32% over the last month. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Particularly, we will be paying attention to Changzhou Xiangming Intelligent Drive System's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Changzhou Xiangming Intelligent Drive System

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 Changzhou Xiangming Intelligent Drive System is:

2.3% = CN¥20m ÷ CN¥899m (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¥0.02 in profit.

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Why Is ROE Important For 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.

Changzhou Xiangming Intelligent Drive System's Earnings Growth And 2.3% ROE

It is quite clear that Changzhou Xiangming Intelligent Drive System's ROE is rather low. Not just that, even compared to the industry average of 6.5%, the company's ROE is entirely unremarkable. For this reason, Changzhou Xiangming Intelligent Drive System's five year net income decline of 24% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

However, when we compared Changzhou Xiangming Intelligent Drive System's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 10% in the same period. This is quite worrisome.

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). This then helps them determine if the stock is placed for a bright or bleak future. Is Changzhou Xiangming Intelligent Drive System fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Changzhou Xiangming Intelligent Drive System Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 60% (implying that 40% of the profits are retained), most of Changzhou Xiangming Intelligent Drive System's profits are being paid to shareholders, which explains the company's shrinking earnings. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. To know the 4 risks we have identified for Changzhou Xiangming Intelligent Drive System visit our risks dashboard for free.

Additionally, Changzhou Xiangming Intelligent Drive System has paid dividends over a period of three years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Summary

Overall, we would be extremely cautious before making any decision on Changzhou Xiangming Intelligent Drive System. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. To gain further insights into Changzhou Xiangming Intelligent Drive System's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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.