Is Guangdong Fenghua Advanced Technology (Holding) Co., Ltd.'s (SZSE:000636) Recent Price Movement Underpinned By Its Weak Fundamentals?

With its stock down 11% over the past three months, it is easy to disregard Guangdong Fenghua Advanced Technology (Holding) (SZSE:000636). We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Specifically, we decided to study Guangdong Fenghua Advanced Technology (Holding)'s ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Guangdong Fenghua Advanced Technology (Holding)

How Is ROE Calculated?

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 Guangdong Fenghua Advanced Technology (Holding) is:

2.7% = CN¥326m ÷ CN¥12b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned 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¥0.03 in profit.

What Has ROE Got To Do With 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. 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.

A Side By Side comparison of Guangdong Fenghua Advanced Technology (Holding)'s Earnings Growth And 2.7% ROE

As you can see, Guangdong Fenghua Advanced Technology (Holding)'s ROE looks pretty weak. Even when compared to the industry average of 6.3%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 12% seen by Guangdong Fenghua Advanced Technology (Holding) over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

That being said, we compared Guangdong Fenghua Advanced Technology (Holding)'s 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 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. 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 Guangdong Fenghua Advanced Technology (Holding)'s's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Guangdong Fenghua Advanced Technology (Holding) Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 31% (that is, a retention ratio of 69%), the fact that Guangdong Fenghua Advanced Technology (Holding)'s 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.

Moreover, Guangdong Fenghua Advanced Technology (Holding) has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

In total, we're a bit ambivalent about Guangdong Fenghua Advanced Technology (Holding)'s performance. 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. 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. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.