Should Weakness in Sunny Optical Technology (Group) Company Limited's (HKG:2382) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

With its stock down 29% over the past three months, it is easy to disregard Sunny Optical Technology (Group) (HKG:2382). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Sunny Optical Technology (Group)'s ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

This technology could replace computers: discover the 20 stocks are working to make quantum computing a reality.

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 Sunny Optical Technology (Group) is:

11% = CN¥2.8b ÷ CN¥25b (Based on the trailing twelve months to December 2024).

The 'return' is the yearly profit. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.11 in profit.

Check out our latest analysis for Sunny Optical Technology (Group)

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

Sunny Optical Technology (Group)'s Earnings Growth And 11% ROE

To begin with, Sunny Optical Technology (Group) seems to have a respectable ROE. On comparing with the average industry ROE of 7.6% the company's ROE looks pretty remarkable. For this reason, Sunny Optical Technology (Group)'s five year net income decline of 23% raises the question as to why the high ROE didn't translate into earnings growth. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

However, when we compared Sunny Optical Technology (Group)'s growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 1.2% in the same period. This is quite worrisome.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is 2382 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Sunny Optical Technology (Group) Making Efficient Use Of Its Profits?

When we piece together Sunny Optical Technology (Group)'s low three-year median payout ratio of 21% (where it is retaining 79% of its profits), calculated for the last three-year period, we are puzzled by the lack of growth. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.

Moreover, Sunny Optical Technology (Group) has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 20%. Still, forecasts suggest that Sunny Optical Technology (Group)'s future ROE will rise to 14% even though the the company's payout ratio is not expected to change by much.

Summary

On the whole, we do feel that Sunny Optical Technology (Group) has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.