Does The Market Have A Low Tolerance For Shanghai Emperor of Cleaning Hi-Tech Co., Ltd's (SHSE:603200) Mixed Fundamentals?

With its stock down 14% over the past three months, it is easy to disregard Shanghai Emperor of Cleaning Hi-Tech (SHSE:603200). We, however decided to study the company's financials to determine if they have got anything to do with the price decline. 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. Specifically, we decided to study Shanghai Emperor of Cleaning Hi-Tech's ROE in this article.

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.

See our latest analysis for Shanghai Emperor of Cleaning Hi-Tech

How Do You Calculate Return On Equity?

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 Emperor of Cleaning Hi-Tech is:

4.6% = CN¥47m ÷ CN¥1.0b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.05 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

A Side By Side comparison of Shanghai Emperor of Cleaning Hi-Tech's Earnings Growth And 4.6% ROE

It is hard to argue that Shanghai Emperor of Cleaning Hi-Tech's ROE is much good in and of itself. Further, we noted that the company's ROE is similar to the industry average of 5.1%. Given the circumstances, the significant decline in net income by 13% seen by Shanghai Emperor of Cleaning Hi-Tech over the last five years is not surprising.

So, as a next step, we compared Shanghai Emperor of Cleaning Hi-Tech'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 4.7% over the last few years.

Earnings growth is a huge factor in stock valuation. 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. 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 Shanghai Emperor of Cleaning Hi-Tech is trading on a high P/E or a low P/E, relative to its industry.

Is Shanghai Emperor of Cleaning Hi-Tech Efficiently Re-investing Its Profits?

Despite having a normal three-year median payout ratio of 32% (where it is retaining 68% of its profits), Shanghai Emperor of Cleaning Hi-Tech has seen a decline in earnings as we saw above. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

In addition, Shanghai Emperor of Cleaning Hi-Tech has been paying dividends over a period of six years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.

Conclusion

Overall, we have mixed feelings about Shanghai Emperor of Cleaning Hi-Tech. 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. 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. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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