Does Guangdong Topstrong Living Innovation and Integration Co., Ltd.'s (SZSE:300749) Weak Fundamentals Mean That The Market Could Correct Its Share Price?

Guangdong Topstrong Living Innovation and Integration (SZSE:300749) has had a great run on the share market with its stock up by a significant 23% over the last three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Specifically, we decided to study Guangdong Topstrong Living Innovation and Integration's ROE in this article.

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.

Check out our latest analysis for Guangdong Topstrong Living Innovation and Integration

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 Guangdong Topstrong Living Innovation and Integration is:

0.6% = CN¥4.2m ÷ CN¥722m (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.01 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Guangdong Topstrong Living Innovation and Integration's Earnings Growth And 0.6% ROE

It is quite clear that Guangdong Topstrong Living Innovation and Integration's ROE is rather low. Even when compared to the industry average of 9.8%, the ROE figure is pretty disappointing. Therefore, it might not be wrong to say that the five year net income decline of 37% seen by Guangdong Topstrong Living Innovation and Integration was possibly a result of it having a lower ROE. 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.

However, when we compared Guangdong Topstrong Living Innovation and Integration's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 6.1% in the same period. This is quite worrisome.

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. This then helps them determine if the stock is placed for a bright or bleak future. Is Guangdong Topstrong Living Innovation and Integration fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Guangdong Topstrong Living Innovation and Integration Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 83% (implying that 17% of the profits are retained), most of Guangdong Topstrong Living Innovation and Integration's profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. You can see the 4 risks we have identified for Guangdong Topstrong Living Innovation and Integration by visiting our risks dashboard for free on our platform here.

In addition, Guangdong Topstrong Living Innovation and Integration has been paying dividends over a period of five years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.

Summary

Overall, we would be extremely cautious before making any decision on Guangdong Topstrong Living Innovation and Integration. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. Up till now, we've only made a short study of the company's growth data. To gain further insights into Guangdong Topstrong Living Innovation and Integration's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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.