Chengdu Gas Group (SHSE:603053) has had a rough week with its share price down 6.5%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Chengdu Gas Group's ROE.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Chengdu Gas Group

How To 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 Chengdu Gas Group is:

12% = CN¥539m ÷ CN¥4.5b (Based on the trailing twelve months to June 2023).

The 'return' refers to a company's earnings over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.12.

What Is The Relationship Between ROE And 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Chengdu Gas Group's Earnings Growth And 12% ROE

To begin with, Chengdu Gas Group seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 9.4%. Despite this, Chengdu Gas Group's five year net income growth was quite low averaging at only 4.3%. That's a bit unexpected from a company which has such a high rate of return. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

Next, on comparing with the industry net income growth, we found that Chengdu Gas Group's reported growth was lower than the industry growth of 7.7% over the last few years, which is not something we like to see.

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. If you're wondering about Chengdu Gas Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Chengdu Gas Group Efficiently Re-investing Its Profits?

Chengdu Gas Group has a three-year median payout ratio of 53% (implying that it keeps only 47% of its profits), meaning that it pays out most of its profits to shareholders as dividends, and as a result, the company has seen low earnings growth.

Moreover, Chengdu Gas Group has been paying dividends for three years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

In total, it does look like Chengdu Gas Group has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 1 risk we have identified for Chengdu Gas Group 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.