Shanghai Dazhong Public Utilities(Group) Co.,Ltd.'s (SHSE:600635) Stock is Soaring But Financials Seem Inconsistent: Will The Uptrend Continue?

Shanghai Dazhong Public Utilities(Group)Ltd (SHSE:600635) has had a great run on the share market with its stock up by a significant 40% over the last three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Specifically, we decided to study Shanghai Dazhong Public Utilities(Group)Ltd's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Shanghai Dazhong Public Utilities(Group)Ltd

How To Calculate Return On Equity?

Return on equity 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 Shanghai Dazhong Public Utilities(Group)Ltd is:

2.2% = CN¥216m ÷ CN¥9.9b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.02 in profit.

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. 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. 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 Shanghai Dazhong Public Utilities(Group)Ltd's Earnings Growth And 2.2% ROE

It is hard to argue that Shanghai Dazhong Public Utilities(Group)Ltd's ROE is much good in and of itself. Not just that, even compared to the industry average of 9.3%, the company's ROE is entirely unremarkable. For this reason, Shanghai Dazhong Public Utilities(Group)Ltd's five year net income decline of 41% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.

However, when we compared Shanghai Dazhong Public Utilities(Group)Ltd's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 10.0% in the same period. This is quite worrisome.

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. Doing so will help them establish if the stock's future looks promising or ominous. Is Shanghai Dazhong Public Utilities(Group)Ltd fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Shanghai Dazhong Public Utilities(Group)Ltd Efficiently Re-investing Its Profits?

Looking at its three-year median payout ratio of 30% (or a retention ratio of 70%) which is pretty normal, Shanghai Dazhong Public Utilities(Group)Ltd's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

In addition, Shanghai Dazhong Public Utilities(Group)Ltd 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.

Summary

In total, we're a bit ambivalent about Shanghai Dazhong Public Utilities(Group)Ltd's performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. 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. You can see the 5 risks we have identified for Shanghai Dazhong Public Utilities(Group)Ltd by visiting our risks dashboard for free on our platform here.

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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.