Does Keystone Electrical (Zhejiang) Co.,Ltd.'s (SZSE:301448) Weak Fundamentals Mean That The Market Could Correct Its Share Price?

Keystone Electrical (Zhejiang)Ltd (SZSE:301448) has had a great run on the share market with its stock up by a significant 21% over the last week. 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. Particularly, we will be paying attention to Keystone Electrical (Zhejiang)Ltd's ROE today.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Keystone Electrical (Zhejiang)Ltd

How To Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for Keystone Electrical (Zhejiang)Ltd is:

8.6% = CN¥58m ÷ CN¥671m (Based on the trailing twelve months to June 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¥0.09 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. 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.

Keystone Electrical (Zhejiang)Ltd's Earnings Growth And 8.6% ROE

When you first look at it, Keystone Electrical (Zhejiang)Ltd's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 10%. But Keystone Electrical (Zhejiang)Ltd saw a five year net income decline of 8.1% over the past five years. Remember, the company's ROE is a bit low to begin with. Therefore, the decline in earnings could also be the result of this.

So, as a next step, we compared Keystone Electrical (Zhejiang)Ltd'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 7.3% over the last few years.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. 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 Keystone Electrical (Zhejiang)Ltd is trading on a high P/E or a low P/E, relative to its industry.

Is Keystone Electrical (Zhejiang)Ltd Making Efficient Use Of Its Profits?

Keystone Electrical (Zhejiang)Ltd's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 54% (or a retention ratio of 46%). The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. To know the 3 risks we have identified for Keystone Electrical (Zhejiang)Ltd visit our risks dashboard for free.

Only recently, Keystone Electrical (Zhejiang)Ltd 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, Keystone Electrical (Zhejiang)Ltd'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. Up till now, we've only made a short study of the company's growth data. You can do your own research on Keystone Electrical (Zhejiang)Ltd and see how it has performed in the past by looking at this FREE detailed graph 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.