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 26% over the last month. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. In this article, we decided to focus on Changzhou Xiangming Intelligent Drive System's ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Changzhou Xiangming Intelligent Drive System

How Do You 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 Changzhou Xiangming Intelligent Drive System is:

3.5% = CN¥32m ÷ CN¥910m (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?

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. 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.

Changzhou Xiangming Intelligent Drive System's Earnings Growth And 3.5% ROE

It is quite clear that Changzhou Xiangming Intelligent Drive System's ROE is rather low. Even when compared to the industry average of 6.9%, the ROE figure is pretty disappointing. For this reason, Changzhou Xiangming Intelligent Drive System's five year net income decline of 13% 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 12% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. 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 Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 59% (implying that 41% 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. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. You can see the 4 risks we have identified for Changzhou Xiangming Intelligent Drive System by visiting our risks dashboard for free on our platform here.

Only recently, Changzhou Xiangming Intelligent Drive System stated paying a dividend. This likely means that the management might have concluded that its shareholders have a strong preference for dividends.

Summary

In total, we would have a hard think before deciding on any investment action concerning 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. So far, we've only made a quick discussion around the company's earnings growth. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com