Renxin New Material Co.,Ltd.'s (SZSE:301395) Stock's Been Going Strong: Could Weak Financials Mean The Market Will Correct Its Share Price?

Renxin New MaterialLtd (SZSE:301395) has had a great run on the share market with its stock up by a significant 17% over the last three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. In this article, we decided to focus on Renxin New MaterialLtd's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

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How Is ROE Calculated?

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 Renxin New MaterialLtd is:

4.0% = CN¥62m ÷ CN¥1.5b (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¥0.04 in profit.

See our latest analysis for Renxin New MaterialLtd

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Renxin New MaterialLtd's Earnings Growth And 4.0% ROE

As you can see, Renxin New MaterialLtd's ROE looks pretty weak. Even compared to the average industry ROE of 6.2%, the company's ROE is quite dismal. For this reason, Renxin New MaterialLtd's five year net income decline of 40% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

So, as a next step, we compared Renxin New MaterialLtd's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 4.1% over the last few years.

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 Renxin New MaterialLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Renxin New MaterialLtd Making Efficient Use Of Its Profits?

Renxin New MaterialLtd's high three-year median payout ratio of 246% suggests that the company is depleting its resources to keep up its dividend payments, and this shows in its shrinking earnings. Paying a dividend higher than reported profits is not a sustainable move. You can see the 3 risks we have identified for Renxin New MaterialLtd by visiting our risks dashboard for free on our platform here.

In addition, Renxin New MaterialLtd only recently started paying a dividend so the management probably decided the shareholders prefer dividends even though earnings have been shrinking.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Renxin New MaterialLtd. The low ROE, combined with the fact that the company is paying out almost if not all, of its profits as dividends, has resulted in the lack or absence of growth in its earnings. Up till now, we've only made a short study of the company's growth data. To gain further insights into Renxin New MaterialLtd's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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.