Ningbo Water Meter (Group) Co.,Ltd. (SHSE:603700) Is Going Strong But Fundamentals Appear To Be Mixed : Is There A Clear Direction For The Stock?

Ningbo Water Meter (Group)Ltd's (SHSE:603700) stock is up by a considerable 18% over the past week. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. Specifically, we decided to study Ningbo Water Meter (Group)Ltd's ROE in this article.

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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Ningbo Water Meter (Group)Ltd

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 Ningbo Water Meter (Group)Ltd is:

7.1% = CN¥110m ÷ CN¥1.6b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. 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.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Ningbo Water Meter (Group)Ltd's Earnings Growth And 7.1% ROE

When you first look at it, Ningbo Water Meter (Group)Ltd's ROE doesn't look that attractive. However, its ROE is similar to the industry average of 6.4%, so we won't completely dismiss the company. But then again, Ningbo Water Meter (Group)Ltd's five year net income shrunk at a rate of 13%. Bear in mind, the company does have a slightly low ROE. So that's what might be causing earnings growth to shrink.

However, when we compared Ningbo Water Meter (Group)Ltd's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 4.7% in the same period. This is quite worrisome.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Ningbo Water Meter (Group)Ltd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Ningbo Water Meter (Group)Ltd Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 46% (where it is retaining 54% of its profits), Ningbo Water Meter (Group)Ltd has seen a decline in earnings as we saw above. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Additionally, Ningbo Water Meter (Group)Ltd has paid dividends over a period of five years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Summary

On the whole, we feel that the performance shown by Ningbo Water Meter (Group)Ltd can be open to many interpretations. 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 3 risks we have identified for Ningbo Water Meter (Group)Ltd by visiting our risks dashboard for free on our platform here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.