Servyou Software Group Co., Ltd.'s (SHSE:603171) On An Uptrend But Financial Prospects Look Pretty Weak: Is The Stock Overpriced?

Servyou Software Group (SHSE:603171) has had a great run on the share market with its stock up by a significant 29% over the last month. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. In this article, we decided to focus on Servyou Software Group's ROE.

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 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 Servyou Software Group

How To Calculate Return On Equity?

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 Servyou Software Group is:

3.4% = CN¥84m ÷ CN¥2.5b (Based on the trailing twelve months to June 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.

Why Is ROE Important For 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. 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.

A Side By Side comparison of Servyou Software Group's Earnings Growth And 3.4% ROE

It is quite clear that Servyou Software Group's ROE is rather low. Even compared to the average industry ROE of 4.5%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 27% seen by Servyou Software Group was possibly a result of it having a 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.

That being said, we compared Servyou Software Group'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 0.8% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. 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. What is 603171 worth today? The intrinsic value infographic in our free research report helps visualize whether 603171 is currently mispriced by the market.

Is Servyou Software Group Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 68% (implying that 32% of the profits are retained), most of Servyou Software Group'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.

Moreover, Servyou Software Group has been paying dividends for three years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 14% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 13%, over the same period.

Summary

In total, we would have a hard think before deciding on any investment action concerning Servyou Software Group. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.