It is hard to get excited after looking at Guangdong Sanhe Pile's (SZSE:003037) recent performance, when its stock has declined 27% over the past three months. 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. Specifically, we decided to study Guangdong Sanhe Pile'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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

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 Guangdong Sanhe Pile is:

3.0% = CN¥84m ÷ CN¥2.8b (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.03 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

A Side By Side comparison of Guangdong Sanhe Pile's Earnings Growth And 3.0% ROE

It is hard to argue that Guangdong Sanhe Pile's ROE is much good in and of itself. Even compared to the average industry ROE of 6.6%, the company's ROE is quite dismal. Given the circumstances, the significant decline in net income by 21% seen by Guangdong Sanhe Pile over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

Next, when we compared with the industry, which has shrunk its earnings at a rate of 1.7% in the same 5-year period, we still found Guangdong Sanhe Pile's performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Guangdong Sanhe Pile's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Guangdong Sanhe Pile Making Efficient Use Of Its Profits?

Looking at its three-year median payout ratio of 39% (or a retention ratio of 61%) which is pretty normal, Guangdong Sanhe Pile's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

In addition, Guangdong Sanhe Pile has been paying dividends over a period of three years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.

Summary

In total, we're a bit ambivalent about Guangdong Sanhe Pile's performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. 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 4 risks we have identified for Guangdong Sanhe Pile 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.