With its stock down 21% over the past three months, it is easy to disregard Zhefu Holding Group (SZSE:002266). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Zhefu Holding Group's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How To 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 Zhefu Holding Group is:

13% = CN¥1.4b ÷ CN¥11b (Based on the trailing twelve months to September 2023).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.13 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

A Side By Side comparison of Zhefu Holding Group's Earnings Growth And 13% ROE

At first glance, Zhefu Holding Group seems to have a decent ROE. Especially when compared to the industry average of 6.1% the company's ROE looks pretty impressive. This probably laid the ground for Zhefu Holding Group's significant 33% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

Next, on comparing with the industry net income growth, we found that Zhefu Holding Group's growth is quite high when compared to the industry average growth of 7.0% in the same period, which is great 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. 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 Zhefu Holding Group is trading on a high P/E or a low P/E, relative to its industry.

Is Zhefu Holding Group Making Efficient Use Of Its Profits?

Zhefu Holding Group has a really low three-year median payout ratio of 20%, meaning that it has the remaining 80% left over to reinvest into its business. So it looks like Zhefu Holding Group is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Besides, Zhefu Holding Group has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.

Summary

In total, we are pretty happy with Zhefu Holding Group's performance. 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 sizeable growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.

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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.