Can Jiangsu Rijiu Optoelectronics Jointstock Co., Ltd's (SZSE:003015) Weak Financials Pull The Plug On The Stock's Current Momentum On Its Share Price?

Most readers would already be aware that Jiangsu Rijiu Optoelectronics' (SZSE:003015) stock increased significantly by 35% over the past three months. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. In this article, we decided to focus on Jiangsu Rijiu Optoelectronics' 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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Jiangsu Rijiu Optoelectronics

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Jiangsu Rijiu Optoelectronics is:

1.6% = CN¥15m ÷ CN¥937m (Based on the trailing twelve months to June 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¥0.02 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. 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.

Jiangsu Rijiu Optoelectronics' Earnings Growth And 1.6% ROE

It is quite clear that Jiangsu Rijiu Optoelectronics' ROE is rather low. Even compared to the average industry ROE of 6.4%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 51% seen by Jiangsu Rijiu Optoelectronics was possibly a result of it having a lower ROE. 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 Jiangsu Rijiu Optoelectronics' 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 4.8% 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. 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 Jiangsu Rijiu Optoelectronics is trading on a high P/E or a low P/E, relative to its industry.

Is Jiangsu Rijiu Optoelectronics Using Its Retained Earnings Effectively?

Jiangsu Rijiu Optoelectronics' declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 83% (or a retention ratio of 17%). With only very little left to reinvest into the business, growth in earnings is far from likely. To know the 3 risks we have identified for Jiangsu Rijiu Optoelectronics visit our risks dashboard for free.

Additionally, Jiangsu Rijiu Optoelectronics has paid dividends over a period of three years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Summary

In total, we would have a hard think before deciding on any investment action concerning Jiangsu Rijiu Optoelectronics. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. Up till now, we've only made a short study of the company's growth data. To gain further insights into Jiangsu Rijiu Optoelectronics' past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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.