Zhubo Design Co., Ltd's (SZSE:300564) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

Zhubo Design's (SZSE:300564) stock is up by a considerable 32% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study Zhubo Design's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Zhubo Design

How Is ROE Calculated?

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 Zhubo Design is:

3.4% = CN¥44m ÷ CN¥1.3b (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.03 in profit.

What Is The Relationship Between ROE And Earnings Growth?

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

Zhubo Design's Earnings Growth And 3.4% ROE

As you can see, Zhubo Design's ROE looks pretty weak. Even when compared to the industry average of 6.2%, the ROE figure is pretty disappointing. Therefore, it might not be wrong to say that the five year net income decline of 6.5% seen by Zhubo Design was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.

So, as a next step, we compared Zhubo Design'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 0.3% over the last few years.

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. 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 Zhubo Design is trading on a high P/E or a low P/E, relative to its industry.

Is Zhubo Design Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 37% (where it is retaining 63% of its profits), Zhubo Design 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.

Moreover, Zhubo Design has been paying dividends for four years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking.

Summary

On the whole, we feel that the performance shown by Zhubo Design can be open to many interpretations. 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. 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. Our risks dashboard would have the 5 risks we have identified for Zhubo Design.

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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.