Should Weakness in Zhejiang Kan Specialities Material Co., Ltd.'s (SZSE:002012) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

Zhejiang Kan Specialities Material (SZSE:002012) has had a rough three months with its share price down 34%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Zhejiang Kan Specialities Material's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Zhejiang Kan Specialities Material

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 Zhejiang Kan Specialities Material is:

0.9% = CN¥15m ÷ CN¥1.7b (Based on the trailing twelve months to March 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¥0.01.

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.

Zhejiang Kan Specialities Material's Earnings Growth And 0.9% ROE

It is hard to argue that Zhejiang Kan Specialities Material's ROE is much good in and of itself. Not just that, even compared to the industry average of 5.7%, the company's ROE is entirely unremarkable. Accordingly, Zhejiang Kan Specialities Material's low net income growth of 3.1% over the past five years can possibly be explained by the low ROE amongst other factors.

We then compared Zhejiang Kan Specialities Material's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 1.0% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 Zhejiang Kan Specialities Material is trading on a high P/E or a low P/E, relative to its industry.

Is Zhejiang Kan Specialities Material Making Efficient Use Of Its Profits?

Zhejiang Kan Specialities Material has a low three-year median payout ratio of 10.0% (meaning, the company keeps the remaining 90% of profits) which means that the company is retaining more of its earnings. However, the low earnings growth number doesn't reflect this as high growth usually follows high profit retention. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, Zhejiang Kan Specialities Material has been paying dividends for seven years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Conclusion

On the whole, we do feel that Zhejiang Kan Specialities Material has some positive attributes. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard would have the 2 risks we have identified for Zhejiang Kan Specialities Material.

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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.

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