Should Weakness in Caihong Display Devices Co.,Ltd.'s (SHSE:600707) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

Caihong Display DevicesLtd (SHSE:600707) has had a rough week with its share price down 10%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Caihong Display DevicesLtd's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Caihong Display DevicesLtd

How To Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Caihong Display DevicesLtd is:

7.3% = CN¥1.6b ÷ CN¥22b (Based on the trailing twelve months to September 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¥0.07 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. 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.

Caihong Display DevicesLtd's Earnings Growth And 7.3% ROE

When you first look at it, Caihong Display DevicesLtd's ROE doesn't look that attractive. 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, Caihong Display DevicesLtd has shown a meagre net income growth of 3.6% over the past five years. Remember, the company's ROE is not particularly great to begin with. Hence, this does provide some context to low earnings growth seen by the company.

We then performed a comparison between Caihong Display DevicesLtd's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 3.9% in the same 5-year period.

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. If you're wondering about Caihong Display DevicesLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Caihong Display DevicesLtd Using Its Retained Earnings Effectively?

Caihong Display DevicesLtd doesn't pay any regular dividends currently which essentially means that it has been reinvesting all of its profits into the business. This doesn't explain the low earnings growth number that we discussed above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Summary

On the whole, we do feel that Caihong Display DevicesLtd has some positive attributes. Specifically, its fairly high earnings growth number, which no doubt was backed by the company's high earnings retention. Still, the low ROE means that all that reinvestment is not reaping a lot of benefit to the investors. 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 Caihong Display DevicesLtd 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.