Declining Stock and Solid Fundamentals: Is The Market Wrong About Xiamen Faratronic Co., Ltd. (SHSE:600563)?

It is hard to get excited after looking at Xiamen Faratronic's (SHSE:600563) recent performance, when its stock has declined 16% 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 Xiamen Faratronic's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Xiamen Faratronic

How To 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 Xiamen Faratronic is:

20% = CN¥1.0b ÷ CN¥5.0b (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.20 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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 Xiamen Faratronic's Earnings Growth And 20% ROE

To begin with, Xiamen Faratronic seems to have a respectable ROE. Especially when compared to the industry average of 6.3% the company's ROE looks pretty impressive. This probably laid the ground for Xiamen Faratronic's significant 21% net income growth seen over the past five years. We reckon that there could also be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Xiamen Faratronic'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 6.4%.

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. What is 600563 worth today? The intrinsic value infographic in our free research report helps visualize whether 600563 is currently mispriced by the market.

Is Xiamen Faratronic Using Its Retained Earnings Effectively?

Xiamen Faratronic's three-year median payout ratio is a pretty moderate 40%, meaning the company retains 60% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Xiamen Faratronic is reinvesting its earnings efficiently.

Additionally, Xiamen Faratronic 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 42% of its profits over the next three years. Accordingly, forecasts suggest that Xiamen Faratronic's future ROE will be 23% which is again, similar to the current ROE.

Conclusion

Overall, we are quite pleased with Xiamen Faratronic's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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.