Should Weakness in Chengdu Xuguang Electronics Co., Ltd.'s (SHSE:600353) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

With its stock down 18% over the past month, it is easy to disregard Chengdu Xuguang Electronics (SHSE:600353). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Chengdu Xuguang Electronics' 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.

See our latest analysis for Chengdu Xuguang Electronics

How Do You Calculate Return On Equity?

Return on equity 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 Chengdu Xuguang Electronics is:

5.3% = CN¥100m ÷ CN¥1.9b (Based on the trailing twelve months to September 2024).

The 'return' is the profit over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.05 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Chengdu Xuguang Electronics' Earnings Growth And 5.3% ROE

At first glance, Chengdu Xuguang Electronics' ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 6.3%, we may spare it some thought. Having said that, Chengdu Xuguang Electronics has shown a modest net income growth of 18% over the past five years. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Chengdu Xuguang Electronics' 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 3.9%.

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). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Chengdu Xuguang Electronics''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Chengdu Xuguang Electronics Efficiently Re-investing Its Profits?

Chengdu Xuguang Electronics has a healthy combination of a moderate three-year median payout ratio of 34% (or a retention ratio of 66%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Additionally, Chengdu Xuguang Electronics has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 30%. Regardless, the future ROE for Chengdu Xuguang Electronics is predicted to rise to 9.7% despite there being not much change expected in its payout ratio.

Conclusion

On the whole, we do feel that Chengdu Xuguang Electronics has some positive attributes. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 1 risk we have identified for Chengdu Xuguang Electronics visit our risks dashboard for free.

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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.