Shenzhen Leaguer Co., Ltd.'s (SZSE:002243) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

Shenzhen Leaguer's (SZSE:002243) stock is up by a considerable 64% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on Shenzhen Leaguer'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Shenzhen Leaguer

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 Shenzhen Leaguer is:

0.8% = CN¥66m ÷ CN¥8.3b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.01 in profit.

Why Is ROE Important For 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.

A Side By Side comparison of Shenzhen Leaguer's Earnings Growth And 0.8% ROE

It is quite clear that Shenzhen Leaguer's ROE is rather low. Not just that, even compared to the industry average of 5.4%, the company's ROE is entirely unremarkable. Given the circumstances, the significant decline in net income by 13% seen by Shenzhen Leaguer over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

As a next step, we compared Shenzhen Leaguer's performance with the industry and found thatShenzhen Leaguer's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 0.005% in the same period, which is a slower than the company.

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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Shenzhen Leaguer's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shenzhen Leaguer Making Efficient Use Of Its Profits?

When we piece together Shenzhen Leaguer's low three-year median payout ratio of 22% (where it is retaining 78% of its profits), calculated for the last three-year period, we are puzzled by the lack of growth. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, Shenzhen Leaguer has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Conclusion

Overall, we have mixed feelings about Shenzhen Leaguer. 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. To know the 5 risks we have identified for Shenzhen Leaguer visit our risks dashboard for free.

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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.