Is Guo Tai Epoint Software Co.,Ltd's (SHSE:688232) Recent Price Movement Underpinned By Its Weak Fundamentals?

Guo Tai Epoint SoftwareLtd (SHSE:688232) has had a rough three months with its share price down 24%. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Particularly, we will be paying attention to Guo Tai Epoint SoftwareLtd's ROE today.

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

View our latest analysis for Guo Tai Epoint SoftwareLtd

How To Calculate Return On Equity?

ROE can be calculated by using the formula:

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

So, based on the above formula, the ROE for Guo Tai Epoint SoftwareLtd is:

4.1% = CN¥228m ÷ CN¥5.5b (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¥0.04 in profit.

What Has ROE Got To Do With 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.

Guo Tai Epoint SoftwareLtd's Earnings Growth And 4.1% ROE

It is quite clear that Guo Tai Epoint SoftwareLtd's ROE is rather low. A comparison with the industry shows that the company's ROE is pretty similar to the average industry ROE of 4.1%. Therefore, it might not be wrong to say that the five year net income decline of 3.5% seen by Guo Tai Epoint SoftwareLtd was possibly a result of the disappointing ROE.

With the industry earnings declining at a rate of 3.2% in the same period, we deduce that both the company and the industry are shrinking at the same rate.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Guo Tai Epoint SoftwareLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Guo Tai Epoint SoftwareLtd Efficiently Re-investing Its Profits?

Looking at its three-year median payout ratio of 36% (or a retention ratio of 64%) which is pretty normal, Guo Tai Epoint SoftwareLtd's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Additionally, Guo Tai Epoint SoftwareLtd 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

In total, we're a bit ambivalent about Guo Tai Epoint SoftwareLtd's performance. 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. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.