Shanghai Yongmaotai Automotive Technology’s (SHSE:605208) stock is up by a considerable 128% 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 Shanghai Yongmaotai Automotive Technology’s ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out 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:

1.8% = CN¥39m ÷ CN¥2.1b (Based on the trailing twelve months to September 2024).

The ‘return’ refers to a company’s earnings over the last year. So, this means that for every CN¥1 of its shareholder’s investments, the company generates a profit of CN¥0.02.

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What Is The Relationship Between ROE And 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don’t necessarily bear these characteristics.

A Side By Side comparison of Shanghai Yongmaotai Automotive Technology’s Earnings Growth And 1.8% ROE

It is quite clear that Shanghai Yongmaotai Automotive Technology’s ROE is rather low. Even when compared to the industry average of 8.4%, the ROE figure is pretty disappointing. Therefore, it might not be wrong to say that the five year net income decline of 36% seen by Shanghai Yongmaotai Automotive Technology was possibly a result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

That being said, we compared Shanghai Yongmaotai Automotive Technology’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 9.3% in the same 5-year 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. Doing so will help them establish if the stock’s future looks promising or ominous. 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 Shanghai Yongmaotai Automotive Technology is trading on a high P/E or a low P/E, relative to its industry.

Is Shanghai Yongmaotai Automotive Technology Making Efficient Use Of Its Profits?

When we piece together Shanghai Yongmaotai Automotive Technology’s low three-year median payout ratio of 14% (where it is retaining 86% 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 could be some other explanations in that regard. For example, the company’s business may be deteriorating.

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

Summary

In total, we’re a bit ambivalent about Shanghai Yongmaotai Automotive Technology’s performance. 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. 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 5 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.