XCMG Construction Machinery Co., Ltd.'s (SZSE:000425) Stock Is Going Strong: Is the Market Following Fundamentals?

Simply Wall St · 10/25 23:00

XCMG Construction Machinery's (SZSE:000425) stock is up by a considerable 17% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on XCMG Construction Machinery's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. 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 XCMG Construction Machinery

How To Calculate Return On Equity?

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 XCMG Construction Machinery is:

8.9% = CN¥5.5b ÷ CN¥61b (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.09 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

A Side By Side comparison of XCMG Construction Machinery's Earnings Growth And 8.9% ROE

On the face of it, XCMG Construction Machinery's ROE is not much to talk about. Although a closer study shows that the company's ROE is higher than the industry average of 6.8% which we definitely can't overlook. Consequently, this likely laid the ground for the decent growth of 8.4% seen over the past five years by XCMG Construction Machinery. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. Therefore, the growth in earnings could also be the result of other factors. E.g the company has a low payout ratio or could belong to a high growth industry.

We then performed a comparison between XCMG Construction Machinery's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 8.4% in the same 5-year period.

past-earnings-growth
SZSE:000425 Past Earnings Growth October 25th 2024

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 XCMG Construction Machinery is trading on a high P/E or a low P/E, relative to its industry.

Is XCMG Construction Machinery Making Efficient Use Of Its Profits?

XCMG Construction Machinery has a three-year median payout ratio of 40%, which implies that it retains the remaining 60% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Additionally, XCMG Construction Machinery has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 40%. Regardless, the future ROE for XCMG Construction Machinery is predicted to rise to 14% despite there being not much change expected in its payout ratio.

Summary

In total, we are pretty happy with XCMG Construction Machinery's performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.