Are Yongsheng Advanced Materials Company Limited's (HKG:3608) Mixed Financials Driving The Negative Sentiment?

Yongsheng Advanced Materials (HKG:3608) has had a rough three months with its share price down 8.1%. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Particularly, we will be paying attention to Yongsheng Advanced Materials' ROE today.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Yongsheng Advanced Materials

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 Yongsheng Advanced Materials is:

4.5% = CN¥64m ÷ CN¥1.4b (Based on the trailing twelve months to June 2020).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every HK$1 worth of equity, the company was able to earn HK$0.04 in profit.

Why Is ROE Important For 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.

Yongsheng Advanced Materials' Earnings Growth And 4.5% ROE

When you first look at it, Yongsheng Advanced Materials' ROE doesn't look that attractive. Next, when compared to the average industry ROE of 6.6%, the company's ROE leaves us feeling even less enthusiastic. For this reason, Yongsheng Advanced Materials' five year net income decline of 7.8% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

That being said, we compared Yongsheng Advanced Materials' 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 0.6% in the same period.

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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Yongsheng Advanced Materials''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Yongsheng Advanced Materials Using Its Retained Earnings Effectively?

Looking at its three-year median payout ratio of 33% (or a retention ratio of 67%) which is pretty normal, Yongsheng Advanced Materials' 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.

Additionally, Yongsheng Advanced Materials has paid dividends over a period of six years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Summary

On the whole, we feel that the performance shown by Yongsheng Advanced Materials can be open to many interpretations. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the 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. You can see the 3 risks we have identified for Yongsheng Advanced Materials 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. 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.
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