With its stock down 16% over the past week, it is easy to disregard Zhejiang Xidamen New MaterialLtd (SHSE:605155). It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Specifically, we decided to study Zhejiang Xidamen New MaterialLtd'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Zhejiang Xidamen New MaterialLtd

How Do You Calculate Return On Equity?

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 Xidamen New MaterialLtd is:

7.1% = CN¥85m ÷ CN¥1.2b (Based on the trailing twelve months to September 2023).

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¥0.07 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 Xidamen New MaterialLtd's Earnings Growth And 7.1% ROE

On the face of it, Zhejiang Xidamen New MaterialLtd's ROE is not much to talk about. However, its ROE is similar to the industry average of 7.4%, so we won't completely dismiss the company. However, Zhejiang Xidamen New MaterialLtd has seen a flattish net income growth over the past five years, which is not saying much. Remember, the company's ROE is not particularly great to begin with. Hence, this provides some context to the flat earnings growth seen by the company.

We then compared Zhejiang Xidamen New MaterialLtd's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 7.0% in the same 5-year period, which is a bit concerning.

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. If you're wondering about Zhejiang Xidamen New MaterialLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Zhejiang Xidamen New MaterialLtd Efficiently Re-investing Its Profits?

In spite of a normal three-year median payout ratio of 29% (or a retention ratio of 71%), Zhejiang Xidamen New MaterialLtd hasn't seen much growth in its earnings. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, Zhejiang Xidamen New MaterialLtd has paid dividends over a period of three years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 30%. Regardless, the future ROE for Zhejiang Xidamen New MaterialLtd is predicted to rise to 12% despite there being not much change expected in its payout ratio.

Summary

In total, we're a bit ambivalent about Zhejiang Xidamen New MaterialLtd'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. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.