Hangzhou Prevail Optoelectronic Equipment Co., Ltd.'s (SZSE:300710) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

Most readers would already be aware that Hangzhou Prevail Optoelectronic Equipment's (SZSE:300710) stock increased significantly by 25% over the past three months. 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. In this article, we decided to focus on Hangzhou Prevail Optoelectronic Equipment's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Hangzhou Prevail Optoelectronic Equipment

How Do You Calculate Return On Equity?

ROE 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 Hangzhou Prevail Optoelectronic Equipment is:

1.3% = CN¥8.8m ÷ CN¥688m (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.01 in profit.

What Has ROE Got To Do With 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Hangzhou Prevail Optoelectronic Equipment's Earnings Growth And 1.3% ROE

It is hard to argue that Hangzhou Prevail Optoelectronic Equipment's ROE is much good in and of itself. Even compared to the average industry ROE of 7.4%, the company's ROE is quite dismal. For this reason, Hangzhou Prevail Optoelectronic Equipment's five year net income decline of 30% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.

That being said, we compared Hangzhou Prevail Optoelectronic Equipment'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 12% in the same 5-year period.

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. This then helps them determine if the stock is placed for a bright or bleak future. Is Hangzhou Prevail Optoelectronic Equipment fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Hangzhou Prevail Optoelectronic Equipment Using Its Retained Earnings Effectively?

While the company did payout a portion of its dividend in the past, it currently doesn't pay a regular dividend. This implies that potentially all of its profits are being reinvested in the business.

Conclusion

In total, we're a bit ambivalent about Hangzhou Prevail Optoelectronic Equipment's performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its 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. Our risks dashboard would have the 3 risks we have identified for Hangzhou Prevail Optoelectronic Equipment.

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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.