Does Heilongjiang Transport Development Co., Ltd.'s (SHSE:601188) Weak Fundamentals Mean That The Market Could Correct Its Share Price?

Heilongjiang Transport Development (SHSE:601188) has had a great run on the share market with its stock up by a significant 43% 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 Heilongjiang Transport Development'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Heilongjiang Transport Development

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 Heilongjiang Transport Development is:

2.3% = CN¥114m ÷ CN¥4.9b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.02 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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 Heilongjiang Transport Development's Earnings Growth And 2.3% ROE

It is hard to argue that Heilongjiang Transport Development'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. Therefore, it might not be wrong to say that the five year net income decline of 23% seen by Heilongjiang Transport Development was possibly a result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

So, as a next step, we compared Heilongjiang Transport Development's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 6.2% over the last few years.

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. If you're wondering about Heilongjiang Transport Development's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Heilongjiang Transport Development Using Its Retained Earnings Effectively?

Heilongjiang Transport Development's 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 61% (or a retention ratio of 39%). The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. Our risks dashboard should have the 2 risks we have identified for Heilongjiang Transport Development.

Additionally, Heilongjiang Transport Development has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Conclusion

Overall, we would be extremely cautious before making any decision on Heilongjiang Transport Development. 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 Heilongjiang Transport Development's 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.