It is hard to get excited after looking at Kangxi Communication Technologies (Shanghai)'s (SHSE:688653) recent performance, when its stock has declined 33% over the past three months. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Kangxi Communication Technologies (Shanghai)'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

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 Kangxi Communication Technologies (Shanghai) is:

1.1% = CN¥11m ÷ CN¥1.0b (Based on the trailing twelve months to December 2023).

The 'return' refers to a company's earnings over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.01 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. 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.

Kangxi Communication Technologies (Shanghai)'s Earnings Growth And 1.1% ROE

It is hard to argue that Kangxi Communication Technologies (Shanghai)'s ROE is much good in and of itself. Not just that, even compared to the industry average of 6.2%, the company's ROE is entirely unremarkable. However, we we're pleasantly surprised to see that Kangxi Communication Technologies (Shanghai) grew its net income at a significant rate of 74% in the last five years. We reckon that there could be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared Kangxi Communication Technologies (Shanghai)'s net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 25% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Kangxi Communication Technologies (Shanghai)'s's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Kangxi Communication Technologies (Shanghai) Using Its Retained Earnings Effectively?

Given that Kangxi Communication Technologies (Shanghai) doesn't pay any regular dividends to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.

Summary

On the whole, we do feel that Kangxi Communication Technologies (Shanghai) has some positive attributes. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 2 risks we have identified for Kangxi Communication Technologies (Shanghai) 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.