Zhejiang Fulai New Material Co.,Ltd. (SHSE:605488) Is Going Strong But Fundamentals Appear To Be Mixed : Is There A Clear Direction For The Stock?

Zhejiang Fulai New MaterialLtd's (SHSE:605488) stock is up by a considerable 27% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. In this article, we decided to focus on Zhejiang Fulai New MaterialLtd'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.

Check out our latest analysis for Zhejiang Fulai New MaterialLtd

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 Zhejiang Fulai New MaterialLtd is:

5.5% = CN¥77m ÷ CN¥1.4b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. 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?

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.

Zhejiang Fulai New MaterialLtd's Earnings Growth And 5.5% ROE

When you first look at it, Zhejiang Fulai New MaterialLtd's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 6.2%. But Zhejiang Fulai New MaterialLtd saw a five year net income decline of 15% over the past five years. Remember, the company's ROE is a bit low to begin with. Hence, this goes some way in explaining the shrinking earnings.

However, when we compared Zhejiang Fulai New MaterialLtd's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 4.9% in the same period. This is quite worrisome.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. If you're wondering about Zhejiang Fulai New MaterialLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Zhejiang Fulai New MaterialLtd Making Efficient Use Of Its Profits?

Looking at its three-year median payout ratio of 47% (or a retention ratio of 53%) which is pretty normal, Zhejiang Fulai New MaterialLtd's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Moreover, Zhejiang Fulai New MaterialLtd has been paying dividends for three years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking.

Summary

Overall, we have mixed feelings about Zhejiang Fulai New MaterialLtd. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the 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. Our risks dashboard would have the 5 risks we have identified for Zhejiang Fulai New MaterialLtd.

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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.