Eastern CommunicationsLtd (SHSE:600776) has had a great run on the share market with its stock up by a significant 6.3% over the last week. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study Eastern CommunicationsLtd'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 Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Eastern CommunicationsLtd is:

4.3% = CN¥150m ÷ CN¥3.5b (Based on the trailing twelve months to December 2023).

The 'return' is the income the business earned over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.04 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. 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. 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.

Eastern CommunicationsLtd's Earnings Growth And 4.3% ROE

It is hard to argue that Eastern CommunicationsLtd's ROE is much good in and of itself. Even when compared to the industry average of 6.3%, the ROE figure is pretty disappointing. Thus, the low net income growth of 4.8% seen by Eastern CommunicationsLtd over the past five years could probably be the result of it having a lower ROE.

We then compared Eastern CommunicationsLtd's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 12% in the same 5-year period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Eastern CommunicationsLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Eastern CommunicationsLtd Making Efficient Use Of Its Profits?

Despite having a normal three-year median payout ratio of 43% (or a retention ratio of 57% over the past three years, Eastern CommunicationsLtd has seen very little growth in earnings as we saw above. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, Eastern CommunicationsLtd has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Conclusion

In total, we're a bit ambivalent about Eastern CommunicationsLtd's performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its 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. To know the 1 risk we have identified for Eastern CommunicationsLtd visit our risks dashboard for free.

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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.