China Meheco Group Co., Ltd.'s (SHSE:600056) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

Simply Wall St · 10/15 22:12

China Meheco Group (SHSE:600056) has had a great run on the share market with its stock up by a significant 13% over the last month. 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. Specifically, we decided to study China Meheco Group'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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for China Meheco Group

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 China Meheco Group is:

7.3% = CN¥1.0b ÷ CN¥14b (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.07.

Why Is ROE Important For 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.

China Meheco Group's Earnings Growth And 7.3% ROE

When you first look at it, China Meheco Group's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 6.5%. But then again, China Meheco Group's five year net income shrunk at a rate of 12%. Remember, the company's ROE is a bit low to begin with. Therefore, the decline in earnings could also be the result of this.

So, as a next step, we compared China Meheco Group'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 4.3% over the last few years.

past-earnings-growth
SHSE:600056 Past Earnings Growth October 15th 2024

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 China Meheco Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is China Meheco Group Efficiently Re-investing Its Profits?

Looking at its three-year median payout ratio of 33% (or a retention ratio of 67%) which is pretty normal, China Meheco Group's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, China Meheco 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 China Meheco Group can be open to many interpretations. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the 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 2 risks we have identified for China Meheco Group.