Does The Market Have A Low Tolerance For Shaanxi Fenghuo Electronics Co., Ltd.'s (SZSE:000561) Mixed Fundamentals?

With its stock down 14% over the past three months, it is easy to disregard Shaanxi Fenghuo Electronics (SZSE:000561). We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. In this article, we decided to focus on Shaanxi Fenghuo 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Shaanxi Fenghuo Electronics

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 Shaanxi Fenghuo Electronics is:

1.0% = CN¥20m ÷ CN¥2.0b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.01 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Shaanxi Fenghuo Electronics' Earnings Growth And 1.0% ROE

It is hard to argue that Shaanxi Fenghuo Electronics' ROE is much good in and of itself. Even when compared to the industry average of 6.2%, the ROE figure is pretty disappointing. Therefore, it might not be wrong to say that the five year net income decline of 3.7% seen by Shaanxi Fenghuo Electronics was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.

So, as a next step, we compared Shaanxi Fenghuo Electronics' performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 15% over the last few years.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Shaanxi Fenghuo Electronics is trading on a high P/E or a low P/E, relative to its industry.

Is Shaanxi Fenghuo Electronics Efficiently Re-investing Its Profits?

Because Shaanxi Fenghuo Electronics doesn't pay any regular dividends, we infer that it is retaining all of its profits, which is rather perplexing when you consider the fact that there is no earnings growth to show for it. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Summary

On the whole, we feel that the performance shown by Shaanxi Fenghuo Electronics 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. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.