Zhejiang Xinao Textiles Inc.'s (SHSE:603889) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

It is hard to get excited after looking at Zhejiang Xinao Textiles' (SHSE:603889) recent performance, when its stock has declined 10% over the past week. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Zhejiang Xinao Textiles' ROE.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Zhejiang Xinao Textiles

How To 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 Zhejiang Xinao Textiles is:

13% = CN¥435m ÷ CN¥3.4b (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.13 in profit.

Why Is ROE Important For 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.

Zhejiang Xinao Textiles' Earnings Growth And 13% ROE

At first glance, Zhejiang Xinao Textiles seems to have a decent ROE. On comparing with the average industry ROE of 7.3% the company's ROE looks pretty remarkable. Probably as a result of this, Zhejiang Xinao Textiles was able to see an impressive net income growth of 24% over the last five years. We reckon that there could also be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Zhejiang Xinao Textiles' 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. Has the market priced in the future outlook for 603889? You can find out in our latest intrinsic value infographic research report.

Is Zhejiang Xinao Textiles Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 51% (implying that it keeps only 49% of profits) for Zhejiang Xinao Textiles suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.

Moreover, Zhejiang Xinao Textiles is determined to keep sharing its profits with shareholders which we infer from its long history of nine years of paying a dividend. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 50%. Accordingly, forecasts suggest that Zhejiang Xinao Textiles' future ROE will be 15% which is again, similar to the current ROE.

Summary

In total, we are pretty happy with Zhejiang Xinao Textiles' performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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