Is GKG Precision Machine Co., Ltd.'s (SZSE:301338) Stock Price Struggling As A Result Of Its Mixed Financials?

It is hard to get excited after looking at GKG Precision Machine's (SZSE:301338) recent performance, when its stock has declined 9.9% over the past week. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on GKG Precision Machine's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

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How Is ROE Calculated?

ROE 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 GKG Precision Machine is:

3.9% = CN¥57m ÷ CN¥1.5b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.04.

Check out our latest analysis for GKG Precision Machine

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

GKG Precision Machine's Earnings Growth And 3.9% ROE

It is hard to argue that GKG Precision Machine's ROE is much good in and of itself. Not just that, even compared to the industry average of 6.4%, the company's ROE is entirely unremarkable. Therefore, it might not be wrong to say that the five year net income decline of 7.6% seen by GKG Precision Machine was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared GKG Precision Machine's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 7.1% in the same period. This is quite worrisome.

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 GKG Precision Machine is trading on a high P/E or a low P/E, relative to its industry.

Is GKG Precision Machine Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 33% (where it is retaining 67% of its profits), GKG Precision Machine 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.

Only recently, GKG Precision Machine stated paying a dividend. This likely means that the management might have concluded that its shareholders have a strong preference for dividends.

Conclusion

Overall, we have mixed feelings about GKG Precision Machine. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. 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. To know the 3 risks we have identified for GKG Precision Machine visit our risks dashboard for free.

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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.