Chengdu Qushui Science and Technology Co., Ltd. (SZSE:301336) Is Going Strong But Fundamentals Appear To Be Mixed : Is There A Clear Direction For The Stock?

Most readers would already be aware that Chengdu Qushui Science and Technology's (SZSE:301336) stock increased significantly by 51% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to Chengdu Qushui Science and Technology'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 Chengdu Qushui Science and Technology

How To Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Chengdu Qushui Science and Technology is:

2.9% = CN¥24m ÷ CN¥802m (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.03 in profit.

What Has ROE Got To Do With Earnings Growth?

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

Chengdu Qushui Science and Technology's Earnings Growth And 2.9% ROE

It is hard to argue that Chengdu Qushui Science and Technology's ROE is much good in and of itself. Even compared to the average industry ROE of 9.3%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 30% seen by Chengdu Qushui Science and Technology was possibly a result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

So, as a next step, we compared Chengdu Qushui Science and Technology'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 8.1% 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. If you're wondering about Chengdu Qushui Science and Technology's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Chengdu Qushui Science and Technology Using Its Retained Earnings Effectively?

Chengdu Qushui Science and Technology's low three-year median payout ratio of 25% (or a retention ratio of 75%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.

Only recently, Chengdu Qushui Science and Technology stated paying a dividend. This likely means that the management might have concluded that its shareholders have a strong preference for dividends.

Conclusion

On the whole, we feel that the performance shown by Chengdu Qushui Science and Technology can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. You can see the 2 risks we have identified for Chengdu Qushui Science and Technology 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.