Can Mixed Fundamentals Have A Negative Impact on Hangzhou Chuhuan Science & Technology Company Limited (SZSE:001336) Current Share Price Momentum?

Most readers would already be aware that Hangzhou Chuhuan Science & Technology's (SZSE:001336) stock increased significantly by 13% over the past month. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. In this article, we decided to focus on Hangzhou Chuhuan Science & Technology'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.

See our latest analysis for Hangzhou Chuhuan Science & Technology

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 Hangzhou Chuhuan Science & Technology is:

4.4% = CN¥34m ÷ CN¥783m (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.04 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Hangzhou Chuhuan Science & Technology's Earnings Growth And 4.4% ROE

It is hard to argue that Hangzhou Chuhuan Science & Technology's ROE is much good in and of itself. Not just that, even compared to the industry average of 6.2%, the company's ROE is entirely unremarkable. Therefore, it might not be wrong to say that the five year net income decline of 9.6% seen by Hangzhou Chuhuan Science & Technology was possibly a result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.

That being said, we compared Hangzhou Chuhuan Science & Technology's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 3.8% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Hangzhou Chuhuan Science & Technology is trading on a high P/E or a low P/E, relative to its industry.

Is Hangzhou Chuhuan Science & Technology Efficiently Re-investing Its Profits?

When we piece together Hangzhou Chuhuan Science & Technology's low three-year median payout ratio of 20% (where it is retaining 80% of its profits), calculated for the last three-year period, we are puzzled by the lack of growth. This typically shouldn't be the case when a company is retaining most of its earnings. 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, Hangzhou Chuhuan Science & Technology 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

On the whole, we feel that the performance shown by Hangzhou Chuhuan Science & Technology can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its 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. You can see the 1 risk we have identified for Hangzhou Chuhuan Science & Technology by visiting our risks dashboard for free on our platform here.

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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.