With its stock down 13% over the past three months, it is easy to disregard Chongqing Water GroupLtd (SHSE:601158). We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. Particularly, we will be paying attention to Chongqing Water GroupLtd's ROE today.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How To Calculate Return On Equity?

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 Chongqing Water GroupLtd is:

5.7% = CN¥993m ÷ CN¥17b (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.06 in profit.

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. 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. 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 Chongqing Water GroupLtd's Earnings Growth And 5.7% ROE

When you first look at it, Chongqing Water GroupLtd's ROE doesn't look that attractive. Next, when compared to the average industry ROE of 7.2%, the company's ROE leaves us feeling even less enthusiastic. Therefore, Chongqing Water GroupLtd's flat earnings over the past five years can possibly be explained by the low ROE amongst other factors.

We then compared Chongqing Water GroupLtd's net income growth with the industry and found that the company's growth figure is a bit less than the average industry growth rate of 1.7% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Chongqing Water GroupLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Chongqing Water GroupLtd Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 68% (implying that the company keeps only 32% of its income) of its business to reinvest into its business), most of Chongqing Water GroupLtd's profits are being paid to shareholders, which explains the absence of growth in earnings.

In addition, Chongqing Water GroupLtd 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.

Summary

On the whole, Chongqing Water GroupLtd's performance is quite a big let-down. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com