Guangzhou Lushan New Materials Co., Ltd. (SHSE:603051) Is Going Strong But Fundamentals Appear To Be Mixed : Is There A Clear Direction For The Stock?

Simply Wall St · 10/15 23:41

Guangzhou Lushan New Materials' (SHSE:603051) stock is up by a considerable 21% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study Guangzhou Lushan New Materials' 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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Guangzhou Lushan New Materials

How Do You 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 Guangzhou Lushan New Materials is:

0.9% = CN¥12m ÷ CN¥1.3b (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.01.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

Guangzhou Lushan New Materials' Earnings Growth And 0.9% ROE

As you can see, Guangzhou Lushan New Materials' ROE looks pretty weak. Not just that, even compared to the industry average of 6.4%, the company's ROE is entirely unremarkable. Therefore, it might not be wrong to say that the five year net income decline of 53% seen by Guangzhou Lushan New Materials was possibly a result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.

However, when we compared Guangzhou Lushan New Materials' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 6.3% in the same period. This is quite worrisome.

past-earnings-growth
SHSE:603051 Past Earnings Growth October 15th 2024

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. 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 Guangzhou Lushan New Materials is trading on a high P/E or a low P/E, relative to its industry.

Is Guangzhou Lushan New Materials Efficiently Re-investing Its Profits?

While the company did payout a portion of its dividend in the past, it currently doesn't pay a regular dividend. This implies that potentially all of its profits are being reinvested in the business.

Summary

Overall, we have mixed feelings about Guangzhou Lushan New Materials. 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 4 risks we have identified for Guangzhou Lushan New Materials.