Zhejiang Chengchang Technology (SZSE:001270) has had a rough three months with its share price down 13%. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Specifically, we decided to study Zhejiang Chengchang Technology'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

How Do You 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 Zhejiang Chengchang Technology is:

3.8% = CN¥53m ÷ CN¥1.4b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax 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¥0.04 in profit.

What Is The Relationship Between ROE And 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of Zhejiang Chengchang Technology's Earnings Growth And 3.8% ROE

It is hard to argue that Zhejiang Chengchang Technology's ROE is much good in and of itself. Even compared to the average industry ROE of 5.8%, the company's ROE is quite dismal. Accordingly, Zhejiang Chengchang Technology's low net income growth of 4.9% over the past five years can possibly be explained by the low ROE amongst other factors.

We then compared Zhejiang Chengchang Technology's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 20% in the same 5-year period, which is a bit concerning.

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. 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 Zhejiang Chengchang Technology's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Zhejiang Chengchang Technology Efficiently Re-investing Its Profits?

Despite having a normal three-year median payout ratio of 30% (or a retention ratio of 70% over the past three years, Zhejiang Chengchang Technology has seen very little growth in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Only recently, Zhejiang Chengchang Technology started paying a dividend. This means that the management might have concluded that its shareholders prefer dividends over earnings growth.

Summary

On the whole, we feel that the performance shown by Zhejiang Chengchang Technology can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.

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