With its stock down 19% over the past three months, it is easy to disregard Zhejiang Zhongcheng Packing Material (SZSE:002522). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Zhejiang Zhongcheng Packing Material'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. 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 ROE is:

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

So, based on the above formula, the ROE for Zhejiang Zhongcheng Packing Material is:

3.0% = CN¥68m ÷ CN¥2.3b (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.03.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Zhejiang Zhongcheng Packing Material's Earnings Growth And 3.0% ROE

As you can see, Zhejiang Zhongcheng Packing Material's ROE looks pretty weak. Even compared to the average industry ROE of 7.1%, the company's ROE is quite dismal. However, the moderate 16% net income growth seen by Zhejiang Zhongcheng Packing Material over the past five years is definitely a positive. 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.

As a next step, we compared Zhejiang Zhongcheng Packing Material's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 11%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Zhejiang Zhongcheng Packing Material is trading on a high P/E or a low P/E, relative to its industry.

Is Zhejiang Zhongcheng Packing Material Using Its Retained Earnings Effectively?

Zhejiang Zhongcheng Packing Material's three-year median payout ratio to shareholders is 22% (implying that it retains 78% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Additionally, Zhejiang Zhongcheng Packing Material has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders.

Conclusion

Overall, we feel that Zhejiang Zhongcheng Packing Material certainly does have some positive factors to consider. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. 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. You can see the 2 risks we have identified for Zhejiang Zhongcheng Packing Material by visiting our risks dashboard for free on our platform here.

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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.