Red Avenue New Materials Group Co., Ltd. (SHSE:603650) Stock Has Shown Weakness Lately But Financials Look Strong: Should Prospective Shareholders Make The Leap?

Red Avenue New Materials Group (SHSE:603650) has had a rough three months with its share price down 7.4%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Red Avenue New Materials Group's ROE.

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

View our latest analysis for Red Avenue New Materials Group

How Is ROE Calculated?

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 Red Avenue New Materials Group is:

15% = CN¥510m ÷ CN¥3.5b (Based on the trailing twelve months to September 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¥0.15.

Why Is ROE Important For Earnings Growth?

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

Red Avenue New Materials Group's Earnings Growth And 15% ROE

To begin with, Red Avenue New Materials Group seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 6.3%. Yet, Red Avenue New Materials Group has posted measly growth of 4.6% over the past five years. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

Next, on comparing Red Avenue New Materials Group's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 4.6% 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. This then helps them determine if the stock is placed for a bright or bleak future. Is Red Avenue New Materials Group fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Red Avenue New Materials Group Efficiently Re-investing Its Profits?

Red Avenue New Materials Group has a low three-year median payout ratio of 20% (meaning, the company keeps the remaining 80% of profits) which means that the company is retaining more of its earnings. However, the low earnings growth number doesn't reflect this fact. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, Red Avenue New Materials Group has paid dividends over a period of six years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 50% over the next three years. Regardless, the future ROE for Red Avenue New Materials Group is speculated to rise to 18% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.

Conclusion

In total, we are pretty happy with Red Avenue New Materials Group's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.