Should Weakness in Shanghai Sanmao Enterprise (Group) Co., Ltd.'s (SHSE:600689) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

With its stock down 11% over the past three months, it is easy to disregard Shanghai Sanmao Enterprise (Group) (SHSE:600689). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Shanghai Sanmao Enterprise (Group)'s ROE today.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Shanghai Sanmao Enterprise (Group)

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 Shanghai Sanmao Enterprise (Group) is:

4.5% = CN¥20m ÷ CN¥448m (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.04 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. 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. 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 Sanmao Enterprise (Group)'s Earnings Growth And 4.5% ROE

It is quite clear that Shanghai Sanmao Enterprise (Group)'s ROE is rather low. Even when compared to the industry average of 7.3%, the ROE figure is pretty disappointing. Accordingly, Shanghai Sanmao Enterprise (Group)'s low net income growth of 3.6% over the past five years can possibly be explained by the low ROE amongst other factors.

As a next step, we compared Shanghai Sanmao Enterprise (Group)'s net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 1.4%.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Shanghai Sanmao Enterprise (Group) fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Shanghai Sanmao Enterprise (Group) Efficiently Re-investing Its Profits?

Shanghai Sanmao Enterprise (Group) doesn't pay any regular dividends, meaning that potentially all of its profits are being reinvested in the business. However, this doesn't explain the low earnings growth the company has seen. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Summary

In total, it does look like Shanghai Sanmao Enterprise (Group) has some positive aspects to its business. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 1 risk we have identified for Shanghai Sanmao Enterprise (Group) 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.

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