Can Mixed Fundamentals Have A Negative Impact on Chengdu Information Technology of Chinese Academy of Sciences Co.,Ltd (SZSE:300678) Current Share Price Momentum?

Chengdu Information Technology of Chinese Academy of SciencesLtd's (SZSE:300678) stock is up by a considerable 86% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on Chengdu Information Technology of Chinese Academy of SciencesLtd'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 Chengdu Information Technology of Chinese Academy of SciencesLtd

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Chengdu Information Technology of Chinese Academy of SciencesLtd is:

2.8% = CN¥24m ÷ CN¥855m (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. 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?

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 Chengdu Information Technology of Chinese Academy of SciencesLtd's Earnings Growth And 2.8% ROE

It is hard to argue that Chengdu Information Technology of Chinese Academy of SciencesLtd's ROE is much good in and of itself. Even compared to the average industry ROE of 4.6%, the company's ROE is quite dismal. For this reason, Chengdu Information Technology of Chinese Academy of SciencesLtd's five year net income decline of 3.6% 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. Such as - low earnings retention or poor allocation of capital.

However, when we compared Chengdu Information Technology of Chinese Academy of SciencesLtd's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 2.5% in the same period. This is quite worrisome.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. 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 Chengdu Information Technology of Chinese Academy of SciencesLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Chengdu Information Technology of Chinese Academy of SciencesLtd Making Efficient Use Of Its Profits?

Chengdu Information Technology of Chinese Academy of SciencesLtd's low three-year median payout ratio of 22% (implying that it retains the remaining 78% of its profits) comes as a surprise when you pair it with the shrinking earnings. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. So there could be some other explanations in that regard. For example, the company's business may be deteriorating.

In addition, Chengdu Information Technology of Chinese Academy of SciencesLtd has been paying dividends over a period of six years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.

Conclusion

Overall, we have mixed feelings about Chengdu Information Technology of Chinese Academy of SciencesLtd. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. You can see the 4 risks we have identified for Chengdu Information Technology of Chinese Academy of SciencesLtd by visiting our risks dashboard for free on our platform here.

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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.