Chengdu Information Technology of Chinese Academy of SciencesLtd's (SZSE:300678) stock is up by a considerable 85% over the past three months. 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 Chengdu Information Technology of Chinese Academy of SciencesLtd'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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

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 Chengdu Information Technology of Chinese Academy of SciencesLtd is:

2.8% = CN¥24m ÷ CN¥855m (Based on the trailing twelve months to September 2024).

The 'return' is the profit over the last twelve months. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.03.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

Chengdu Information Technology of Chinese Academy of SciencesLtd's Earnings Growth And 2.8% ROE

It is hard to argue that Chengdu Information Technology of Chinese Academy of SciencesLtd's ROE is much good in and of itself. Even compared to the average industry ROE of 4.6%, the company's ROE is quite dismal. For this reason, Chengdu Information Technology of Chinese Academy of SciencesLtd's five year net income decline of 3.6% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

That being said, we compared Chengdu Information Technology of Chinese Academy of SciencesLtd's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 2.5% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. 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 Chengdu Information Technology of Chinese Academy of SciencesLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Chengdu Information Technology of Chinese Academy of SciencesLtd Efficiently Re-investing Its Profits?

When we piece together Chengdu Information Technology of Chinese Academy of SciencesLtd's low three-year median payout ratio of 22% (where it is retaining 78% of its profits), calculated for the last three-year period, we are puzzled by the lack of growth. This typically shouldn't be the case when a company is retaining most of its earnings. So there could be some other explanations in that regard. For example, the company's business may be deteriorating.

Moreover, Chengdu Information Technology of Chinese Academy of SciencesLtd has been paying dividends for seven years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking.

Conclusion

Overall, we have mixed feelings about Chengdu Information Technology of Chinese Academy of SciencesLtd. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. 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. You can see the 4 risks we have identified for Chengdu Information Technology of Chinese Academy of SciencesLtd by visiting our risks dashboard for free on our platform here.

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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.