Qifeng New Material (SZSE:002521) has had a rough month with its share price down 16%. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Specifically, we decided to study Qifeng New Material'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 Do You Calculate Return On Equity?

ROE can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Qifeng New Material is:

4.5% = CN¥163m ÷ CN¥3.7b (Based on the trailing twelve months to September 2023).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.04 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

Qifeng New Material's Earnings Growth And 4.5% ROE

It is hard to argue that Qifeng New Material's ROE is much good in and of itself. An industry comparison shows that the company's ROE is not much different from the industry average of 3.9% either. Given the low ROE Qifeng New Material's five year net income decline of 5.5% is not surprising.

However, when we compared Qifeng New Material's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 7.7% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. 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 Qifeng New Material's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Qifeng New Material Using Its Retained Earnings Effectively?

Looking at its three-year median payout ratio of 32% (or a retention ratio of 68%) which is pretty normal, Qifeng New Material's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Moreover, Qifeng New Material has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

On the whole, we feel that the performance shown by Qifeng New Material can be open to many interpretations. 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. To know the 2 risks we have identified for Qifeng New Material 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.