Are Shanghai Zhongzhou Special Alloy Materials Co., Ltd.'s (SZSE:300963) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

It is hard to get excited after looking at Shanghai Zhongzhou Special Alloy Materials' (SZSE:300963) recent performance, when its stock has declined 18% over the past three months. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on Shanghai Zhongzhou Special Alloy Materials' ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Shanghai Zhongzhou Special Alloy Materials

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 Shanghai Zhongzhou Special Alloy Materials is:

7.5% = CN¥78m ÷ CN¥1.0b (Based on the trailing twelve months to September 2024).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.07 in profit.

What Is The Relationship Between ROE And 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.

A Side By Side comparison of Shanghai Zhongzhou Special Alloy Materials' Earnings Growth And 7.5% ROE

On the face of it, Shanghai Zhongzhou Special Alloy Materials' ROE is not much to talk about. However, its ROE is similar to the industry average of 7.5%, so we won't completely dismiss the company. On the other hand, Shanghai Zhongzhou Special Alloy Materials reported a moderate 10% net income growth over the past five years. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Shanghai Zhongzhou Special Alloy Materials' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 9.8% 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. 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 Shanghai Zhongzhou Special Alloy Materials is trading on a high P/E or a low P/E, relative to its industry.

Is Shanghai Zhongzhou Special Alloy Materials Efficiently Re-investing Its Profits?

In Shanghai Zhongzhou Special Alloy Materials' case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 24% (or a retention ratio of 76%), which suggests that the company is investing most of its profits to grow its business.

Moreover, Shanghai Zhongzhou Special Alloy Materials is determined to keep sharing its profits with shareholders which we infer from its long history of four years of paying a dividend. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 18% over the next three years. The fact that the company's ROE is expected to rise to 13% over the same period is explained by the drop in the payout ratio.

Conclusion

In total, it does look like Shanghai Zhongzhou Special Alloy Materials has some positive aspects to its business. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.