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 54% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study Chengdu Qushui Science and Technology'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.

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 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.

See our latest analysis for Chengdu Qushui Science and Technology

What Is The Relationship Between ROE And Earnings Growth?

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

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

It is quite clear that Chengdu Qushui Science and Technology's ROE is rather low. Even when compared to the industry average of 9.8%, the ROE figure is pretty disappointing. For this reason, Chengdu Qushui Science and Technology's five year net income decline of 30% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

That being said, we compared Chengdu Qushui Science and Technology's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 7.8% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 Chengdu Qushui Science and Technology is trading on a high P/E or a low P/E, relative to its industry.

Is Chengdu Qushui Science and Technology Efficiently Re-investing Its Profits?

When we piece together Chengdu Qushui Science and Technology's low three-year median payout ratio of 25% (where it is retaining 75% of its profits), calculated for the last three-year period, we are puzzled by the lack of growth. 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.

In addition, Chengdu Qushui Science and Technology only recently started paying a dividend so the management probably decided the shareholders prefer dividends even though earnings have been shrinking.

Conclusion

Overall, we have mixed feelings about Chengdu Qushui Science and Technology. 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 3 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.