Nanxing Machinery (SZSE:002757) has had a rough month with its share price down 17%. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. In this article, we decided to focus on Nanxing Machinery's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

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 Nanxing Machinery is:

6.2% = CN¥149m ÷ CN¥2.4b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.06 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 Nanxing Machinery's Earnings Growth And 6.2% ROE

On the face of it, Nanxing Machinery's ROE is not much to talk about. However, given that the company's ROE is similar to the average industry ROE of 6.3%, we may spare it some thought. Having said that, Nanxing Machinery's net income growth over the past five years is more or less flat. Bear in mind, the company's ROE is not very high. So that could also be one of the reasons behind the company's flat growth in earnings.

Next, on comparing with the industry net income growth, we found that the industry grew its earnings by 7.4% over the last few years.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Nanxing Machinery is trading on a high P/E or a low P/E, relative to its industry.

Is Nanxing Machinery Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 61% (implying that the company keeps only 39% of its income) of its business to reinvest into its business), most of Nanxing Machinery's profits are being paid to shareholders, which explains the absence of growth in earnings.

In addition, Nanxing Machinery has been paying dividends over a period of nine years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Summary

On the whole, Nanxing Machinery's performance is quite a big let-down. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. So far, we've only made a quick discussion around the company's earnings growth. You can do your own research on Nanxing Machinery and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.

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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.