Yinchuan Xinhua Commercial (Group)'s (SHSE:600785) stock is up by a considerable 40% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Specifically, we decided to study Yinchuan Xinhua Commercial (Group)'s ROE in this article.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How To Calculate Return On Equity?
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 Yinchuan Xinhua Commercial (Group) is:
3.9% = CN¥75m ÷ CN¥1.9b (Based on the trailing twelve months to September 2023).
The 'return' is the amount earned after tax over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥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. 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.
Yinchuan Xinhua Commercial (Group)'s Earnings Growth And 3.9% ROE
It is hard to argue that Yinchuan Xinhua Commercial (Group)'s ROE is much good in and of itself. Not just that, even compared to the industry average of 5.3%, the company's ROE is entirely unremarkable. For this reason, Yinchuan Xinhua Commercial (Group)'s five year net income decline of 10% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate of 6.7% over the last few years, we found that Yinchuan Xinhua Commercial (Group)'s performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Yinchuan Xinhua Commercial (Group)'s's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Yinchuan Xinhua Commercial (Group) Using Its Retained Earnings Effectively?
Yinchuan Xinhua Commercial (Group)'s low three-year median payout ratio of 21% (implying that it retains the remaining 79% of its profits) comes as a surprise when you pair it with the shrinking earnings. This typically shouldn't be the case when a company is retaining most of its earnings. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.
In addition, Yinchuan Xinhua Commercial (Group) has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.
Conclusion
On the whole, we feel that the performance shown by Yinchuan Xinhua Commercial (Group) can be open to many interpretations. 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. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.
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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.