Guizhou Zhenhua Fengguang Semiconductor Co., Ltd. (SHSE:688439) Stock Has Shown Weakness Lately But Financials Look Strong: Should Prospective Shareholders Make The Leap?

It is hard to get excited after looking at Guizhou Zhenhua Fengguang Semiconductor's (SHSE:688439) recent performance, when its stock has declined 20% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Guizhou Zhenhua Fengguang Semiconductor's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Guizhou Zhenhua Fengguang Semiconductor

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 Guizhou Zhenhua Fengguang Semiconductor is:

12% = CN¥610m ÷ CN¥4.9b (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.12 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. 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 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.

A Side By Side comparison of Guizhou Zhenhua Fengguang Semiconductor's Earnings Growth And 12% ROE

At first glance, Guizhou Zhenhua Fengguang Semiconductor seems to have a decent ROE. On comparing with the average industry ROE of 5.8% the company's ROE looks pretty remarkable. This certainly adds some context to Guizhou Zhenhua Fengguang Semiconductor's exceptional 42% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

Next, on comparing with the industry net income growth, we found that Guizhou Zhenhua Fengguang Semiconductor's growth is quite high when compared to the industry average growth of 20% in the same period, which is great to see.

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. Doing so will help them establish if the stock's future looks promising or ominous. 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 Guizhou Zhenhua Fengguang Semiconductor is trading on a high P/E or a low P/E, relative to its industry.

Is Guizhou Zhenhua Fengguang Semiconductor Using Its Retained Earnings Effectively?

Guizhou Zhenhua Fengguang Semiconductor has a really low three-year median payout ratio of 20%, meaning that it has the remaining 80% left over to reinvest into its business. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Along with seeing a growth in earnings, Guizhou Zhenhua Fengguang Semiconductor only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders.

Summary

On the whole, we feel that Guizhou Zhenhua Fengguang Semiconductor's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.