Most readers would already be aware that China Baoan Group's (SZSE:000009) stock increased significantly by 30% over the past three months. 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. Particularly, we will be paying attention to China Baoan Group'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 Is ROE Calculated?

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 China Baoan Group is:

5.1% = CN¥1.1b ÷ CN¥22b (Based on the trailing twelve months to September 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¥0.05 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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 China Baoan Group's Earnings Growth And 5.1% ROE

At first glance, China Baoan Group's ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 8.0% either. However, the moderate 11% net income growth seen by China Baoan Group over the past five years is definitely a positive. We reckon that there could be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared China Baoan Group's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 16% in the same 5-year period, which is a bit concerning.

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. 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 China Baoan Group is trading on a high P/E or a low P/E, relative to its industry.

Is China Baoan Group Making Efficient Use Of Its Profits?

China Baoan Group has a low three-year median payout ratio of 8.9%, meaning that the company retains the remaining 91% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Additionally, China Baoan Group has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders.

Summary

In total, it does look like China Baoan Group has some positive aspects to its business. That is, a decent growth in earnings backed by a high rate of reinvestment. However, we do feel that that earnings growth could have been higher if the business were to improve on the low ROE rate. Especially given how the company is reinvesting a huge chunk of its profits. 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. To know the 2 risks we have identified for China Baoan Group visit our risks dashboard for free.

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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.