It is hard to get excited after looking at Hangzhou Cogeneration Group's (SHSE:605011) recent performance, when its stock has declined 19% over the past three months. However, stock prices are usually driven by a company's financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Hangzhou Cogeneration Group's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How To 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 Hangzhou Cogeneration Group is:

10% = CN¥278m ÷ CN¥2.7b (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.10.

What Has ROE Got To Do With 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. 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 Hangzhou Cogeneration Group's Earnings Growth And 10% ROE

When you first look at it, Hangzhou Cogeneration Group's ROE doesn't look that attractive. Although a closer study shows that the company's ROE is higher than the industry average of 5.6% which we definitely can't overlook. But seeing Hangzhou Cogeneration Group's five year net income decline of 3.8% over the past five years, we might rethink that. Bear in mind, the company does have a slightly low ROE. It is just that the industry ROE is lower. Therefore, the decline in earnings could also be the result of this.

From the 3.8% decline reported by the industry in the same period, we infer that Hangzhou Cogeneration Group and its industry are both shrinking at a similar rate.

Earnings growth is a huge factor in stock valuation. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. What is 605011 worth today? The intrinsic value infographic in our free research report helps visualize whether 605011 is currently mispriced by the market.

Is Hangzhou Cogeneration Group Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 30% (that is, a retention ratio of 70%), the fact that Hangzhou Cogeneration Group's earnings have shrunk is quite puzzling. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Additionally, Hangzhou Cogeneration Group has paid dividends over a period of three years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Summary

Overall, we feel that Hangzhou Cogeneration Group certainly does have some positive factors to consider. However, while the company does have a decent ROE and a high profit retention, its earnings growth number is quite disappointing. This suggests that there might be some external threat to the business, that's hampering growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard would have the 2 risks we have identified for Hangzhou Cogeneration Group.

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