Most readers would already know that Shenzhen Tellus Holding's (SZSE:000025) stock increased by 9.8% over the past three months. Given that the stock prices usually follow long-term business performance, we wonder if the company's mixed financials could have any adverse effect on its current price price movement Particularly, we will be paying attention to Shenzhen Tellus Holding'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Shenzhen Tellus Holding

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 Shenzhen Tellus Holding is:

5.7% = CN¥97m ÷ CN¥1.7b (Based on the trailing twelve months to September 2023).

The 'return' is the profit 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¥0.06 in profit.

Why Is ROE Important For Earnings Growth?

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

Shenzhen Tellus Holding's Earnings Growth And 5.7% ROE

On the face of it, Shenzhen Tellus Holding's ROE is not much to talk about. However, its ROE is similar to the industry average of 5.3%, so we won't completely dismiss the company. But then again, Shenzhen Tellus Holding's five year net income shrunk at a rate of 4.5%. Bear in mind, the company does have a slightly low ROE. So that's what might be causing earnings growth to shrink.

However, when we compared Shenzhen Tellus Holding's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 0.8% in the same period. This is quite worrisome.

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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Shenzhen Tellus Holding's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shenzhen Tellus Holding Making Efficient Use Of Its Profits?

Shenzhen Tellus Holding's low three-year median payout ratio of 12% (or a retention ratio of 88%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. This typically shouldn't be the case when a company is retaining most of its earnings. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.

Additionally, Shenzhen Tellus Holding has paid dividends over a period of four years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Summary

In total, we're a bit ambivalent about Shenzhen Tellus Holding's performance. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. 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. Our risks dashboard would have the 2 risks we have identified for Shenzhen Tellus Holding.

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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.