Declining Stock and Solid Fundamentals: Is The Market Wrong About Shenzhen Farben Information Technology Co.,Ltd. (SZSE:300925)?

It is hard to get excited after looking at Shenzhen Farben Information TechnologyLtd's (SZSE:300925) recent performance, when its stock has declined 21% 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 Shenzhen Farben Information TechnologyLtd'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Shenzhen Farben Information TechnologyLtd

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 Shenzhen Farben Information TechnologyLtd is:

6.6% = CN¥138m ÷ CN¥2.1b (Based on the trailing twelve months to September 2024).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.07 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Shenzhen Farben Information TechnologyLtd's Earnings Growth And 6.6% ROE

On the face of it, Shenzhen Farben Information TechnologyLtd's ROE is not much to talk about. However, the fact that the its ROE is quite higher to the industry average of 4.6% doesn't go unnoticed by us. Yet, Shenzhen Farben Information TechnologyLtd has posted measly growth of 3.6% over the past five years. Bear in mind, the company does have a low ROE. It is just that the industry ROE is lower. Therefore, the low growth in earnings could also be the result of this.

As a next step, we compared Shenzhen Farben Information TechnologyLtd's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 2.5%.

Earnings growth is a huge factor in stock valuation. 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. 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 Shenzhen Farben Information TechnologyLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Shenzhen Farben Information TechnologyLtd Using Its Retained Earnings Effectively?

A low three-year median payout ratio of 11% (implying that the company retains the remaining 89% of its income) suggests that Shenzhen Farben Information TechnologyLtd is retaining most of its profits. This should be reflected in its earnings growth number, but that's not the case. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

In addition, Shenzhen Farben Information TechnologyLtd has been paying dividends over a period of four years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Conclusion

Overall, we are quite pleased with Shenzhen Farben Information TechnologyLtd's performance. In particular, it's great to see that the company has seen significant growth in its earnings backed by a respectable ROE and a high reinvestment rate. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. You can see the 1 risk we have identified for Shenzhen Farben Information TechnologyLtd 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.