Chongqing Fuling Zhacai Group (SZSE:002507) has had a great run on the share market with its stock up by a significant 20% over the last month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Chongqing Fuling Zhacai Group's ROE.

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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How Do You Calculate Return On Equity?

Return on equity can be calculated by using the formula:

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

So, based on the above formula, the ROE for Chongqing Fuling Zhacai Group is:

9.6% = CN¥804m ÷ CN¥8.3b (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.10 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. 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 Chongqing Fuling Zhacai Group's Earnings Growth And 9.6% ROE

When you first look at it, Chongqing Fuling Zhacai Group's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 8.0%. Even so, Chongqing Fuling Zhacai Group has shown a fairly decent growth in its net income which grew at a rate of 6.6%. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

We then compared Chongqing Fuling Zhacai Group's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 1.9% in the same 5-year period.

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. Is Chongqing Fuling Zhacai Group fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Chongqing Fuling Zhacai Group Efficiently Re-investing Its Profits?

With a three-year median payout ratio of 39% (implying that the company retains 61% of its profits), it seems that Chongqing Fuling Zhacai Group is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Moreover, Chongqing Fuling Zhacai Group is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 40%. As a result, Chongqing Fuling Zhacai Group's ROE is not expected to change by much either, which we inferred from the analyst estimate of 10.0% for future ROE.

Summary

On the whole, we do feel that Chongqing Fuling Zhacai Group has some positive attributes. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. 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 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.