Long Young Electronic (Kunshan) Co., Ltd.'s (SZSE:301389) Stock Going Strong But Fundamentals Look Weak: What Implications Could This Have On The Stock?

Long Young Electronic (Kunshan) (SZSE:301389) has had a great run on the share market with its stock up by a significant 15% over the last three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. In this article, we decided to focus on Long Young Electronic (Kunshan)'s 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.

Check out our latest analysis for Long Young Electronic (Kunshan)

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 Long Young Electronic (Kunshan) is:

4.4% = CN¥95m ÷ CN¥2.2b (Based on the trailing twelve months to March 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 Has ROE Got To Do With Earnings Growth?

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

A Side By Side comparison of Long Young Electronic (Kunshan)'s Earnings Growth And 4.4% ROE

It is hard to argue that Long Young Electronic (Kunshan)'s ROE is much good in and of itself. Not just that, even compared to the industry average of 6.3%, the company's ROE is entirely unremarkable. Given the circumstances, the significant decline in net income by 6.1% seen by Long Young Electronic (Kunshan) over the last five years is not surprising. 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 Long Young Electronic (Kunshan)'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 6.4% 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. Doing so will help them establish if the stock's future looks promising or ominous. 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 Long Young Electronic (Kunshan) is trading on a high P/E or a low P/E, relative to its industry.

Is Long Young Electronic (Kunshan) Efficiently Re-investing Its Profits?

Long Young Electronic (Kunshan)'s high three-year median payout ratio of 105% suggests that the company is depleting its resources to keep up its dividend payments, and this shows in its shrinking earnings. Paying a dividend higher than reported profits is not a sustainable move. You can see the 3 risks we have identified for Long Young Electronic (Kunshan) by visiting our risks dashboard for free on our platform here.

Additionally, Long Young Electronic (Kunshan) started paying a dividend only recently. So it looks like the management may have perceived that shareholders favor dividends even though earnings have been in decline.

Conclusion

Overall, we would be extremely cautious before making any decision on Long Young Electronic (Kunshan). The low ROE, combined with the fact that the company is paying out almost if not all, of its profits as dividends, has resulted in the lack or absence of growth in its earnings. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com