With its stock down 19% over the past three months, it is easy to disregard China Railway Construction Heavy Industry (SHSE:688425). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on China Railway Construction Heavy Industry's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. 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 China Railway Construction Heavy Industry

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for China Railway Construction Heavy Industry is:

12% = CN¥1.8b ÷ CN¥15b (Based on the trailing twelve months to March 2022).

The 'return' is the yearly profit. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.12 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

China Railway Construction Heavy Industry's Earnings Growth And 12% ROE

At first glance, China Railway Construction Heavy Industry seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 8.2%. Probably as a result of this, China Railway Construction Heavy Industry was able to see a decent growth of 7.7% over the last five years.

Next, on comparing with the industry net income growth, we found that China Railway Construction Heavy Industry's reported growth was lower than the industry growth of 14% in the same period, which is not something we like to see.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 China Railway Construction Heavy Industry is trading on a high P/E or a low P/E, relative to its industry.

Is China Railway Construction Heavy Industry Efficiently Re-investing Its Profits?

With a three-year median payout ratio of 27% (implying that the company retains 73% of its profits), it seems that China Railway Construction Heavy Industry is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Summary

On the whole, we feel that China Railway Construction Heavy Industry's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a respectable growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. Our risks dashboard would have the 3 risks we have identified for China Railway Construction Heavy Industry.

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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.