Is China Merchants Shekou Industrial Zone Holdings Co., Ltd.'s (SZSE:001979) Recent Price Movement Underpinned By Its Weak Fundamentals?

China Merchants Shekou Industrial Zone Holdings (SZSE:001979) has had a rough three months with its share price down 16%. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Specifically, we decided to study China Merchants Shekou Industrial Zone Holdings' ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for China Merchants Shekou Industrial Zone Holdings

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 China Merchants Shekou Industrial Zone Holdings is:

2.4% = CN¥7.0b ÷ CN¥288b (Based on the trailing twelve months to September 2024).

The 'return' is the profit over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.02 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

China Merchants Shekou Industrial Zone Holdings' Earnings Growth And 2.4% ROE

As you can see, China Merchants Shekou Industrial Zone Holdings' ROE looks pretty weak. Not just that, even compared to the industry average of 3.8%, the company's ROE is entirely unremarkable. Therefore, it might not be wrong to say that the five year net income decline of 25% seen by China Merchants Shekou Industrial Zone Holdings was possibly a result of it having a lower ROE. 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.

Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate of 11% over the last few years, we found that China Merchants Shekou Industrial Zone Holdings' performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about China Merchants Shekou Industrial Zone Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is China Merchants Shekou Industrial Zone Holdings Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 49% (where it is retaining 51% of its profits), China Merchants Shekou Industrial Zone Holdings 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.

In addition, China Merchants Shekou Industrial Zone Holdings has been paying dividends over a period of nine years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 47%. Regardless, the future ROE for China Merchants Shekou Industrial Zone Holdings is predicted to rise to 5.0% despite there being not much change expected in its payout ratio.

Summary

On the whole, we feel that the performance shown by China Merchants Shekou Industrial Zone Holdings can be open to many interpretations. 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. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.