Jiangsu Hongde Special Parts Co.,Ltd. (SZSE:301163) Is Going Strong But Fundamentals Appear To Be Mixed : Is There A Clear Direction For The Stock?

Jiangsu Hongde Special PartsLtd's (SZSE:301163) stock is up by a considerable 10% over the past week. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. Specifically, we decided to study Jiangsu Hongde Special PartsLtd's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Jiangsu Hongde Special PartsLtd

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Jiangsu Hongde Special PartsLtd is:

3.5% = CN¥39m ÷ CN¥1.1b (Based on the trailing twelve months to June 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¥0.03 in profit.

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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Jiangsu Hongde Special PartsLtd's Earnings Growth And 3.5% ROE

As you can see, Jiangsu Hongde Special PartsLtd's ROE looks pretty weak. Not just that, even compared to the industry average of 7.7%, the company's ROE is entirely unremarkable. Therefore, it might not be wrong to say that the five year net income decline of 11% seen by Jiangsu Hongde Special PartsLtd was possibly a result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared Jiangsu Hongde Special PartsLtd's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 10% 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. 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 Jiangsu Hongde Special PartsLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Jiangsu Hongde Special PartsLtd Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 40% (where it is retaining 60% of its profits), Jiangsu Hongde Special PartsLtd has seen a decline in earnings as we saw above. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Additionally, Jiangsu Hongde Special PartsLtd started paying a dividend only recently. So it looks like the management may have perceived that shareholders favor dividends even though earnings have been in decline.

Conclusion

Overall, we have mixed feelings about Jiangsu Hongde Special PartsLtd. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. 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 2 risks we have identified for Jiangsu Hongde Special PartsLtd.

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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.