Shanghai Yongmaotai Automotive Technology (SHSE:605208) has had a rough three months with its share price down 31%. It seems that the market might have completely ignored the positive aspects of the company’s fundamentals and decided to weigh-in more on the negative aspects. Long-term fundamentals are usually what drive market outcomes, so it’s worth paying close attention. Specifically, we decided to study Shanghai Yongmaotai Automotive Technology’s ROE in this article.

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.

View our latest analysis for Shanghai Yongmaotai Automotive Technology

How Is ROE Calculated?

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 Shanghai Yongmaotai Automotive Technology is:

2.9% = CN¥60m ÷ CN¥2.1b (Based on the trailing twelve months to September 2023).

The ‘return’ is the profit over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.03 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or “retains”, and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Shanghai Yongmaotai Automotive Technology’s Earnings Growth And 2.9% ROE

It is hard to argue that Shanghai Yongmaotai Automotive Technology’s ROE is much good in and of itself. Even when compared to the industry average of 7.3%, the ROE figure is pretty disappointing. For this reason, Shanghai Yongmaotai Automotive Technology’s five year net income decline of 15% 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 example, the business has allocated capital poorly, or that the company has a very high payout ratio.

So, as a next step, we compared Shanghai Yongmaotai Automotive Technology’s performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 3.8% over the last few years.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company’s expected earnings growth (or decline). 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 Shanghai Yongmaotai Automotive Technology’s’s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shanghai Yongmaotai Automotive Technology Using Its Retained Earnings Effectively?

When we piece together Shanghai Yongmaotai Automotive Technology’s low three-year median payout ratio of 13% (where it is retaining 87% of its profits), calculated for the last three-year period, we are puzzled by the lack of growth. 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.

Additionally, Shanghai Yongmaotai Automotive Technology has paid dividends over a period of three years, which means that the company’s management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Summary

Overall, we have mixed feelings about Shanghai Yongmaotai Automotive Technology. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. 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 4 risks we have identified for Shanghai Yongmaotai Automotive Technology.

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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.