Can Mixed Fundamentals Have A Negative Impact on Jiangsu Innovative Ecological New Materials Limited (HKG:2116) Current Share Price Momentum?

Most readers would already be aware that Jiangsu Innovative Ecological New Materials' (HKG:2116) stock increased significantly by 11% over the past week. 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. In this article, we decided to focus on Jiangsu Innovative Ecological New Materials' ROE.

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.

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How Do You 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 Jiangsu Innovative Ecological New Materials is:

6.0% = CN¥14m ÷ CN¥232m (Based on the trailing twelve months to December 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each HK$1 of shareholders' capital it has, the company made HK$0.06 in profit.

View our latest analysis for Jiangsu Innovative Ecological New Materials

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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.

Jiangsu Innovative Ecological New Materials' Earnings Growth And 6.0% ROE

When you first look at it, Jiangsu Innovative Ecological New Materials' ROE doesn't look that attractive. However, its ROE is similar to the industry average of 7.2%, so we won't completely dismiss the company. But Jiangsu Innovative Ecological New Materials saw a five year net income decline of 10% over the past five years. Bear in mind, the company does have a slightly low ROE. Hence, this goes some way in explaining the shrinking earnings.

However, when we compared Jiangsu Innovative Ecological New Materials' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 4.6% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Jiangsu Innovative Ecological New Materials''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Jiangsu Innovative Ecological New Materials Using Its Retained Earnings Effectively?

Looking at its three-year median payout ratio of 34% (or a retention ratio of 66%) which is pretty normal, Jiangsu Innovative Ecological New 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.

In addition, Jiangsu Innovative Ecological New Materials has been paying dividends over a period of six years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.

Conclusion

In total, we're a bit ambivalent about Jiangsu Innovative Ecological New Materials' 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. Our risks dashboard would have the 3 risks we have identified for Jiangsu Innovative Ecological New Materials.

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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.