Guangdong Champion Asia ElectronicsLtd (SHSE:603386) has had a rough three months with its share price down 19%. 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. Specifically, we decided to study Guangdong Champion Asia ElectronicsLtd's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How Is ROE Calculated?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Guangdong Champion Asia ElectronicsLtd is:

8.4% = CN¥129m ÷ CN¥1.5b (Based on the trailing twelve months to September 2023).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.08 in profit.

Why Is ROE Important For Earnings Growth?

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

Guangdong Champion Asia ElectronicsLtd's Earnings Growth And 8.4% ROE

At first glance, Guangdong Champion Asia ElectronicsLtd's ROE doesn't look very promising. However, the fact that the company's ROE is higher than the average industry ROE of 6.6%, is definitely interesting. Particularly, the substantial 24% net income growth seen by Guangdong Champion Asia ElectronicsLtd over the past five years is impressive . That being said, the company does have a slightly low ROE to begin with, just that it is higher than the industry average. Therefore, the growth in earnings could also be the result of other factors. Such as- high earnings retention or the company belonging to a high growth industry.

We then compared Guangdong Champion Asia ElectronicsLtd's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 11% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. 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 Guangdong Champion Asia ElectronicsLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Guangdong Champion Asia ElectronicsLtd Using Its Retained Earnings Effectively?

Guangdong Champion Asia ElectronicsLtd's three-year median payout ratio is a pretty moderate 44%, meaning the company retains 56% of its income. So it seems that Guangdong Champion Asia ElectronicsLtd is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Besides, Guangdong Champion Asia ElectronicsLtd has been paying dividends over a period of six years. This shows that the company is committed to sharing profits with its shareholders.

Conclusion

In total, we are pretty happy with Guangdong Champion Asia ElectronicsLtd's performance. Specifically, we like that it has been reinvesting a high portion of its profits at a moderate rate of return, resulting in earnings expansion. 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. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. Our risks dashboard would have the 2 risks we have identified for Guangdong Champion Asia ElectronicsLtd.

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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.