Zhejiang Wanfeng Auto Wheel (SZSE:002085) has had a rough week with its share price down 21%. 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 Zhejiang Wanfeng Auto Wheel's ROE in this article.

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

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 Zhejiang Wanfeng Auto Wheel is:

11% = CN¥1.1b ÷ CN¥9.6b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.11 in profit.

What Has ROE Got To Do With 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Zhejiang Wanfeng Auto Wheel's Earnings Growth And 11% ROE

To begin with, Zhejiang Wanfeng Auto Wheel seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 8.3%. However, we are curious as to how the high returns still resulted in flat growth for Zhejiang Wanfeng Auto Wheel in the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

Next, on comparing with the industry net income growth, we found that Zhejiang Wanfeng Auto Wheel's reported growth was lower than the industry growth of 9.2% over the last few years, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. What is 002085 worth today? The intrinsic value infographic in our free research report helps visualize whether 002085 is currently mispriced by the market.

Is Zhejiang Wanfeng Auto Wheel Efficiently Re-investing Its Profits?

Despite having a normal three-year median payout ratio of 38% (implying that the company keeps 62% of its income) over the last three years, Zhejiang Wanfeng Auto Wheel has seen a negligible amount of growth in earnings as we saw above. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, Zhejiang Wanfeng Auto Wheel has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 60% over the next three years. Regardless, the future ROE for Zhejiang Wanfeng Auto Wheel is speculated to rise to 16% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.

Summary

In total, it does look like Zhejiang Wanfeng Auto Wheel has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.