Is The Market Rewarding Luxi Chemical Group Co., Ltd. (SZSE:000830) With A Negative Sentiment As A Result Of Its Mixed Fundamentals?

Luxi Chemical Group (SZSE:000830) has had a rough three months with its share price down 5.0%. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on Luxi Chemical Group's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Luxi Chemical Group

How To Calculate Return On Equity?

ROE 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 Luxi Chemical Group is:

10% = CN¥1.9b ÷ CN¥18b (Based on the trailing twelve months to September 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.10 in profit.

What Is The Relationship Between ROE And 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. 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.

Luxi Chemical Group's Earnings Growth And 10% ROE

When you first look at it, Luxi Chemical Group's ROE doesn't look that attractive. Although a closer study shows that the company's ROE is higher than the industry average of 6.2% which we definitely can't overlook. Still, Luxi Chemical Group has seen a flat net income growth over the past five years. Remember, the company's ROE is a bit low to begin with, just that it is higher than the industry average. Hence, this goes some way in explaining the flat earnings growth.

As a next step, we compared Luxi Chemical Group's net income growth with the industry and discovered that the industry saw an average growth of 4.9% in the same period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for 000830? You can find out in our latest intrinsic value infographic research report.

Is Luxi Chemical Group Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 58% (meaning, the company retains only 42% of profits) for Luxi Chemical Group suggests that the company's earnings growth was miniscule as a result of paying out a majority of its earnings.

In addition, Luxi Chemical Group 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 31% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.

Summary

On the whole, we feel that the performance shown by Luxi Chemical Group can be open to many interpretations. Specifically, the low earnings growth is a bit concerning, especially given that the company has a respectable rate of return. Investors may have benefitted, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.