Is China Steel Corporation's (TWSE:2002) Stock On A Downtrend As A Result Of Its Poor Financials?

With its stock down 13% over the past three months, it is easy to disregard China Steel (TWSE:2002). Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. Particularly, we will be paying attention to China Steel's ROE today.

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

Check out our latest analysis for China Steel

How Is ROE Calculated?

ROE 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 China Steel is:

1.6% = NT$5.6b ÷ NT$343b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each NT$1 of shareholders' capital it has, the company made NT$0.02 in profit.

What Is The Relationship Between ROE And 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.

A Side By Side comparison of China Steel's Earnings Growth And 1.6% ROE

It is hard to argue that China Steel's ROE is much good in and of itself. Not just that, even compared to the industry average of 5.8%, the company's ROE is entirely unremarkable. Therefore, it might not be wrong to say that the five year net income decline of 6.6% seen by China Steel was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

That being said, we compared China Steel'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 14% in the same 5-year period.

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. Doing so will help them establish if the stock's future looks promising or ominous. Is China Steel fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is China Steel Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 87% (implying that 13% of the profits are retained), most of China Steel's profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely.

Additionally, China Steel has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 67% over the next three years. As a result, the expected drop in China Steel's payout ratio explains the anticipated rise in the company's future ROE to 3.1%, over the same period.

Summary

In total, we would have a hard think before deciding on any investment action concerning China Steel. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.