It is hard to get excited after looking at Shenzhen Cereals HoldingsLtd's (SZSE:000019) recent performance, when its stock has declined 5.6% over the past month. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. In this article, we decided to focus on Shenzhen Cereals HoldingsLtd'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 Shenzhen Cereals HoldingsLtd

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 Shenzhen Cereals HoldingsLtd is:

9.6% = CN¥456m ÷ CN¥4.7b (Based on the trailing twelve months to September 2022).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.10 in profit.

What Is The Relationship Between ROE And 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.

Shenzhen Cereals HoldingsLtd's Earnings Growth And 9.6% ROE

When you first look at it, Shenzhen Cereals HoldingsLtd's ROE doesn't look that attractive. Although a closer study shows that the company's ROE is higher than the industry average of 7.6% which we definitely can't overlook. Yet, Shenzhen Cereals HoldingsLtd has posted measly growth of 3.1% over the past five years. Remember, the company's ROE is quite low to begin with, just that it is higher than the industry average. So that could be one of the factors that are causing earnings growth to stay low.

We then compared Shenzhen Cereals HoldingsLtd's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 7.1% in the same period, which is a bit concerning.

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). 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 Shenzhen Cereals HoldingsLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shenzhen Cereals HoldingsLtd Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 63% (that is, the company retains only 37% of its income) over the past three years for Shenzhen Cereals HoldingsLtd suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.

In addition, Shenzhen Cereals HoldingsLtd 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.

Summary

Overall, we have mixed feelings about Shenzhen Cereals HoldingsLtd. Specifically, the low earnings growth is a bit concerning, especially given that the company has a respectable rate of return. Investors may have benefitted, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. 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 2 risks we have identified for Shenzhen Cereals HoldingsLtd 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.