Can Shenzhen China Micro Semicon Co., Ltd.'s (SHSE:688380) Weak Financials Pull The Plug On The Stock's Current Momentum On Its Share Price?

Shenzhen China Micro Semicon's (SHSE:688380) stock is up by a considerable 72% over the past 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 Shenzhen China Micro Semicon's ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Shenzhen China Micro Semicon

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 Shenzhen China Micro Semicon is:

3.2% = CN¥95m ÷ CN¥3.0b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.03 in profit.

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. 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.

Shenzhen China Micro Semicon's Earnings Growth And 3.2% ROE

As you can see, Shenzhen China Micro Semicon's ROE looks pretty weak. Not just that, even compared to the industry average of 6.4%, the company's ROE is entirely unremarkable. For this reason, Shenzhen China Micro Semicon's five year net income decline of 36% 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.

That being said, we compared Shenzhen China Micro Semicon's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 14% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. 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. Is Shenzhen China Micro Semicon fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Shenzhen China Micro Semicon Making Efficient Use Of Its Profits?

With a high LTM (or last twelve month) payout ratio of 77% (implying that 23% of the profits are retained), most of Shenzhen China Micro Semicon's profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 4 risks we have identified for Shenzhen China Micro Semicon by visiting our risks dashboard for free on our platform here.

Additionally, Shenzhen China Micro Semicon 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

On the whole, Shenzhen China Micro Semicon's performance is quite a big let-down. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. So far, we've only made a quick discussion around the company's earnings growth. You can do your own research on Shenzhen China Micro Semicon and see how it has performed in the past by looking at this FREE detailed graph 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.