Do Fundamentals Have Any Role To Play In Driving Sichuan Changhong Electric Co.,Ltd.'s (SHSE:600839) Stock Up Recently?

Sichuan Changhong ElectricLtd's (SHSE:600839) stock up by 6.1% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Sichuan Changhong ElectricLtd'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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Sichuan Changhong ElectricLtd

How Do You Calculate Return On Equity?

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 Sichuan Changhong ElectricLtd is:

8.1% = CN¥2.0b ÷ CN¥24b (Based on the trailing twelve months to March 2024).

The 'return' is the profit over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.08 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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.

Sichuan Changhong ElectricLtd's Earnings Growth And 8.1% ROE

At first glance, Sichuan Changhong ElectricLtd's ROE doesn't look very promising. However, its ROE is similar to the industry average of 9.8%, so we won't completely dismiss the company. Looking at Sichuan Changhong ElectricLtd's exceptional 40% five-year net income growth in particular, we are definitely impressed. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Sichuan Changhong ElectricLtd'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 6.1%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Sichuan Changhong ElectricLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Sichuan Changhong ElectricLtd Efficiently Re-investing Its Profits?

The three-year median payout ratio for Sichuan Changhong ElectricLtd is 27%, which is moderately low. The company is retaining the remaining 73%. By the looks of it, the dividend is well covered and Sichuan Changhong ElectricLtd is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Besides, Sichuan Changhong ElectricLtd has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.

Summary

In total, it does look like Sichuan Changhong ElectricLtd has some positive aspects to its business. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. 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 2 risks we have identified for Sichuan Changhong ElectricLtd by visiting our risks dashboard for free on our platform here.

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

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.