Can Nan Ren Lake Leisure Amusement Co., Ltd.'s (GTSM:5905) Weak Financials Pull The Plug On The Stock's Current Momentum On Its Share Price?

Nan Ren Lake Leisure Amusement (GTSM:5905) has had a great run on the share market with its stock up by a significant 10% 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. Particularly, we will be paying attention to Nan Ren Lake Leisure Amusement's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Nan Ren Lake Leisure Amusement

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 Nan Ren Lake Leisure Amusement is:

1.1% = NT$30m ÷ NT$2.6b (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. That means that for every NT$1 worth of shareholders' equity, the company generated NT$0.01 in profit.

Why Is ROE Important For Earnings Growth?

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

Nan Ren Lake Leisure Amusement's Earnings Growth And 1.1% ROE

It is quite clear that Nan Ren Lake Leisure Amusement's ROE is rather low. Not just that, even compared to the industry average of 7.1%, the company's ROE is entirely unremarkable. Therefore, it might not be wrong to say that the five year net income decline of 13% seen by Nan Ren Lake Leisure Amusement was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

That being said, we compared Nan Ren Lake Leisure Amusement's 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 2.1% 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Nan Ren Lake Leisure Amusement is trading on a high P/E or a low P/E, relative to its industry.

Is Nan Ren Lake Leisure Amusement Making Efficient Use Of Its Profits?

Nan Ren Lake Leisure Amusement has a high three-year median payout ratio of 93% (that is, it is retaining 7.3% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. 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. You can see the 4 risks we have identified for Nan Ren Lake Leisure Amusement by visiting our risks dashboard for free on our platform here.

In addition, Nan Ren Lake Leisure Amusement has been paying dividends over a period of seven years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.

Conclusion

On the whole, Nan Ren Lake Leisure Amusement's performance is quite a big let-down. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. So it may be worth checking this free detailed graph of Nan Ren Lake Leisure Amusement's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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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