Shanghai Shentong Metro Co.,Ltd. (SHSE:600834) Is Going Strong But Fundamentals Appear To Be Mixed : Is There A Clear Direction For The Stock?

Shanghai Shentong MetroLtd (SHSE:600834) has had a great run on the share market with its stock up by a significant 23% over the last three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study Shanghai Shentong MetroLtd's ROE in this article.

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 Shanghai Shentong MetroLtd

How To Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for Shanghai Shentong MetroLtd is:

3.5% = CN¥63m ÷ CN¥1.8b (Based on the trailing twelve months to September 2024).

The 'return' is the profit over the last twelve months. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.04.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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 Shanghai Shentong MetroLtd's Earnings Growth And 3.5% ROE

As you can see, Shanghai Shentong MetroLtd's ROE looks pretty weak. Even when compared to the industry average of 4.4%, the ROE figure is pretty disappointing. Hence, the flat earnings seen by Shanghai Shentong MetroLtd over the past five years could probably be the result of it having a lower ROE.

As a next step, we compared Shanghai Shentong MetroLtd's performance with the industry and found thatShanghai Shentong MetroLtd's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 0.6% in the same period, which is a slower than the company.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Shanghai Shentong MetroLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Shanghai Shentong MetroLtd Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 30% (or a retention ratio of 70%), Shanghai Shentong MetroLtd hasn't seen much growth in its earnings. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

In addition, Shanghai Shentong MetroLtd has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Conclusion

On the whole, we feel that the performance shown by Shanghai Shentong MetroLtd can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. You can do your own research on Shanghai Shentong MetroLtd and see how it has performed in the past by looking at this FREE detailed graph 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.