Shanghai SK Petroleum & Chemical Equipment Corporation Ltd.'s (SZSE:002278) Stock Going Strong But Fundamentals Look Weak: What Implications Could This Have On The Stock?

Most readers would already be aware that Shanghai SK Petroleum & Chemical Equipment's (SZSE:002278) stock increased significantly by 44% over the past 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 Shanghai SK Petroleum & Chemical Equipment's ROE in this article.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Shanghai SK Petroleum & Chemical Equipment

How Do You 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 Shanghai SK Petroleum & Chemical Equipment is:

3.9% = CN¥47m ÷ CN¥1.2b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned 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¥0.04 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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.

Shanghai SK Petroleum & Chemical Equipment's Earnings Growth And 3.9% ROE

It is quite clear that Shanghai SK Petroleum & Chemical Equipment's ROE is rather low. Even when compared to the industry average of 6.3%, the ROE figure is pretty disappointing. For this reason, Shanghai SK Petroleum & Chemical Equipment's five year net income decline of 23% 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.

However, when we compared Shanghai SK Petroleum & Chemical Equipment's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 12% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. 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. If you're wondering about Shanghai SK Petroleum & Chemical Equipment's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shanghai SK Petroleum & Chemical Equipment Efficiently Re-investing Its Profits?

Shanghai SK Petroleum & Chemical Equipment'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 65% (or a retention ratio of 35%). With only very little left to reinvest into the business, growth in earnings is far from likely. To know the 3 risks we have identified for Shanghai SK Petroleum & Chemical Equipment visit our risks dashboard for free.

In addition, Shanghai SK Petroleum & Chemical Equipment has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Shanghai SK Petroleum & Chemical Equipment. 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. You can do your own research on Shanghai SK Petroleum & Chemical Equipment and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.