It is hard to get excited after looking at Sichuan Changhong ElectricLtd's (SHSE:600839) recent performance, when its stock has declined 19% over the past three months. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on Sichuan Changhong ElectricLtd's ROE.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

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 Sichuan Changhong ElectricLtd is:

8.1% = CN¥2.0b ÷ CN¥24b (Based on the trailing twelve months to March 2024).

The 'return' is the profit over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.08 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company's earnings growth potential. 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.

Sichuan Changhong ElectricLtd's Earnings Growth And 8.1% ROE

When you first look at it, Sichuan Changhong ElectricLtd's ROE doesn't look that attractive. However, its ROE is similar to the industry average of 9.8%, so we won't completely dismiss the company. Looking at Sichuan Changhong ElectricLtd's exceptional 40% five-year net income growth in particular, we are definitely impressed. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

We then compared Sichuan Changhong ElectricLtd'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 5.7% in the same 5-year period.

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 Sichuan Changhong ElectricLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Sichuan Changhong ElectricLtd Efficiently Re-investing Its Profits?

The three-year median payout ratio for Sichuan Changhong ElectricLtd is 27%, which is moderately low. The company is retaining the remaining 73%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Sichuan Changhong ElectricLtd is reinvesting its earnings efficiently.

Moreover, Sichuan Changhong ElectricLtd is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Conclusion

Overall, we feel that Sichuan Changhong ElectricLtd certainly does have some positive factors to consider. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. 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 Sichuan Changhong ElectricLtd 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com