MEGA P&C Advanced Materials (Shanghai) Company Limited's (SHSE:603062) On An Uptrend But Financial Prospects Look Pretty Weak: Is The Stock Overpriced?

MEGA P&C Advanced Materials (Shanghai) (SHSE:603062) has had a great run on the share market with its stock up by a significant 16% over the last week. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. Particularly, we will be paying attention to MEGA P&C Advanced Materials (Shanghai)'s ROE today.

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.

See our latest analysis for MEGA P&C Advanced Materials (Shanghai)

How Is ROE Calculated?

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 MEGA P&C Advanced Materials (Shanghai) is:

6.3% = CN¥128m ÷ CN¥2.0b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.06.

What Has ROE Got To Do With Earnings Growth?

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

A Side By Side comparison of MEGA P&C Advanced Materials (Shanghai)'s Earnings Growth And 6.3% ROE

On the face of it, MEGA P&C Advanced Materials (Shanghai)'s ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 6.4%. But then again, MEGA P&C Advanced Materials (Shanghai)'s five year net income shrunk at a rate of 15%. Remember, the company's ROE is a bit low to begin with. So that's what might be causing earnings growth to shrink.

That being said, we compared MEGA P&C Advanced Materials (Shanghai)'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 6.2% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. 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 MEGA P&C Advanced Materials (Shanghai) is trading on a high P/E or a low P/E, relative to its industry.

Is MEGA P&C Advanced Materials (Shanghai) Making Efficient Use Of Its Profits?

MEGA P&C Advanced Materials (Shanghai)'s high three-year median payout ratio of 166% suggests that the company is depleting its resources to keep up its dividend payments, and this shows in its shrinking earnings. Paying a dividend beyond their means is usually not viable over the long term. Our risks dashboard should have the 3 risks we have identified for MEGA P&C Advanced Materials (Shanghai).

Our latest analyst data shows that the future payout ratio of the company is expected to drop to 44% over the next three years. As a result, the expected drop in MEGA P&C Advanced Materials (Shanghai)'s payout ratio explains the anticipated rise in the company's future ROE to 13%, over the same period.

Summary

Overall, we would be extremely cautious before making any decision on MEGA P&C Advanced Materials (Shanghai). The low ROE, combined with the fact that the company is paying out almost if not all, of its profits as dividends, has resulted in the lack or absence of growth in its earnings. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.