Shunfa Hengneng Corporation's (SZSE:000631) On An Uptrend But Financial Prospects Look Pretty Weak: Is The Stock Overpriced?

Shunfa Hengneng's (SZSE:000631) stock is up by a considerable 12% over the past month. 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. Specifically, we decided to study Shunfa Hengneng's ROE in this article.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Shunfa Hengneng

How Is ROE Calculated?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Shunfa Hengneng is:

2.1% = CN¥123m ÷ CN¥5.8b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.02 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. 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.

Shunfa Hengneng's Earnings Growth And 2.1% ROE

It is hard to argue that Shunfa Hengneng's ROE is much good in and of itself. Even when compared to the industry average of 3.8%, the ROE figure is pretty disappointing. For this reason, Shunfa Hengneng's five year net income decline of 21% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

As a next step, we compared Shunfa Hengneng's performance with the industry and found thatShunfa Hengneng's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 11% in the same period, which is a slower than the company.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Shunfa Hengneng's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shunfa Hengneng Using Its Retained Earnings Effectively?

With a three-year median payout ratio as high as 202%,Shunfa Hengneng's shrinking earnings don't come as a surprise as the company is paying a dividend which is beyond its means. Its usually very hard to sustain dividend payments that are higher than reported profits. You can see the 2 risks we have identified for Shunfa Hengneng by visiting our risks dashboard for free on our platform here.

Moreover, Shunfa Hengneng 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 would be extremely cautious before making any decision on Shunfa Hengneng. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. So far, we've only made a quick discussion around the company's earnings growth. To gain further insights into Shunfa Hengneng'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.