Xiamen Yanjan New Material Co., Ltd.'s (SZSE:300658) On An Uptrend But Financial Prospects Look Pretty Weak: Is The Stock Overpriced?

Most readers would already be aware that Xiamen Yanjan New Material's (SZSE:300658) stock increased significantly by 14% over the past month. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. Specifically, we decided to study Xiamen Yanjan New Material's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Xiamen Yanjan New Material

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Xiamen Yanjan New Material is:

1.7% = CN¥23m ÷ CN¥1.4b (Based on the trailing twelve months to September 2024).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.02 in profit.

Why Is ROE Important For Earnings Growth?

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

Xiamen Yanjan New Material's Earnings Growth And 1.7% ROE

It is hard to argue that Xiamen Yanjan New Material's ROE is much good in and of itself. Not just that, even compared to the industry average of 6.9%, the company's ROE is entirely unremarkable. Given the circumstances, the significant decline in net income by 46% seen by Xiamen Yanjan New Material over the last five years is not surprising. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

So, as a next step, we compared Xiamen Yanjan New Material'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 2.8% over the last few years.

Earnings growth is an important metric to consider when valuing a stock. 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. Is Xiamen Yanjan New Material fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Xiamen Yanjan New Material Using Its Retained Earnings Effectively?

Xiamen Yanjan New Material has a high three-year median payout ratio of 58% (that is, it is retaining 42% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. You can see the 5 risks we have identified for Xiamen Yanjan New Material by visiting our risks dashboard for free on our platform here.

In addition, Xiamen Yanjan New Material has been paying dividends over a period of seven years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.

Conclusion

On the whole, Xiamen Yanjan New Material's performance is quite a big let-down. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. So it may be worth checking this free detailed graph of Xiamen Yanjan New Material's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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.