ShenZhen GAD Environmental Technology Co., Ltd. (SZSE:300854) Is Going Strong But Fundamentals Appear To Be Mixed : Is There A Clear Direction For The Stock?

ShenZhen GAD Environmental Technology's (SZSE:300854) stock is up by a considerable 13% over the past three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. In this article, we decided to focus on ShenZhen GAD Environmental Technology's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for ShenZhen GAD Environmental Technology

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 ShenZhen GAD Environmental Technology is:

2.6% = CN¥26m ÷ CN¥1.0b (Based on the trailing twelve months to June 2024).

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¥0.03 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

ShenZhen GAD Environmental Technology's Earnings Growth And 2.6% ROE

As you can see, ShenZhen GAD Environmental Technology's ROE looks pretty weak. Even compared to the average industry ROE of 5.9%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 43% seen by ShenZhen GAD Environmental 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.

However, when we compared ShenZhen GAD Environmental Technology's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 3.8% in the same period. This is quite worrisome.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about ShenZhen GAD Environmental Technology's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is ShenZhen GAD Environmental Technology Making Efficient Use Of Its Profits?

When we piece together ShenZhen GAD Environmental Technology's low three-year median payout ratio of 21% (where it is retaining 79% 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 could be some other explanations in that regard. For example, the company's business may be deteriorating.

In addition, ShenZhen GAD Environmental Technology only recently started paying a dividend so the management probably decided the shareholders prefer dividends even though earnings have been shrinking.

Summary

On the whole, we feel that the performance shown by ShenZhen GAD Environmental Technology 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. 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. You can see the 3 risks we have identified for ShenZhen GAD Environmental Technology by visiting our risks dashboard for free on our platform here.

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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.