Can Mixed Fundamentals Have A Negative Impact on Beijing Labtech Instruments Co., Ltd. (SHSE:688056) Current Share Price Momentum?

Most readers would already be aware that Beijing Labtech Instruments' (SHSE:688056) stock increased significantly by 25% over the past week. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Particularly, we will be paying attention to Beijing Labtech Instruments' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Beijing Labtech Instruments

How To Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for Beijing Labtech Instruments is:

3.5% = CN¥29m ÷ CN¥807m (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.04 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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Beijing Labtech Instruments' Earnings Growth And 3.5% ROE

It is hard to argue that Beijing Labtech Instruments' ROE is much good in and of itself. Even when compared to the industry average of 6.4%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 16% seen by Beijing Labtech Instruments over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

That being said, we compared Beijing Labtech Instruments' performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 4.7% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. 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 Beijing Labtech Instruments is trading on a high P/E or a low P/E, relative to its industry.

Is Beijing Labtech Instruments Making Efficient Use Of Its Profits?

In spite of a normal three-year median payout ratio of 35% (that is, a retention ratio of 65%), the fact that Beijing Labtech Instruments' earnings have shrunk is quite puzzling. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

In addition, Beijing Labtech Instruments has been paying dividends over a period of four years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 16% over the next three years. The fact that the company's ROE is expected to rise to 6.8% over the same period is explained by the drop in the payout ratio.

Conclusion

In total, we're a bit ambivalent about Beijing Labtech Instruments' performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.