Keystone Electrical (Zhejiang)Ltd (SZSE:301448) has had a rough week with its share price down 13%. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. In this article, we decided to focus on Keystone Electrical (Zhejiang)Ltd'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 Keystone Electrical (Zhejiang)Ltd

How Is ROE Calculated?

Return on equity 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 Keystone Electrical (Zhejiang)Ltd is:

8.0% = CN¥52m ÷ CN¥647m (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.08.

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. 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.

Keystone Electrical (Zhejiang)Ltd's Earnings Growth And 8.0% ROE

On the face of it, Keystone Electrical (Zhejiang)Ltd's ROE is not much to talk about. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 10%. Thus, the low net income growth of 2.6% seen by Keystone Electrical (Zhejiang)Ltd over the past five years could probably be the result of the low ROE.

Next, on comparing with the industry net income growth, we found that Keystone Electrical (Zhejiang)Ltd's reported growth was lower than the industry growth of 7.8% over the last few years, 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. 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 Keystone Electrical (Zhejiang)Ltd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Keystone Electrical (Zhejiang)Ltd Using Its Retained Earnings Effectively?

Keystone Electrical (Zhejiang)Ltd's low three-year median payout ratio of 19% (or a retention ratio of 81%) should mean that the company is retaining most of its earnings to fuel its growth. This should be reflected in its earnings growth number, but that's not the case. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Conclusion

On the whole, we feel that the performance shown by Keystone Electrical (Zhejiang)Ltd can be open to many interpretations. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. 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 3 risks we have identified for Keystone Electrical (Zhejiang)Ltd 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.