Most readers would already be aware that Jiangsu Changhai Composite Materials' (SZSE:300196) stock increased significantly by 12% over the past month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Jiangsu Changhai Composite Materials' 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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

How Do You Calculate Return On Equity?

Return on equity 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 Jiangsu Changhai Composite Materials is:

4.6% = CN¥207m ÷ CN¥4.5b (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.05 in profit.

Why Is ROE Important For 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.

A Side By Side comparison of Jiangsu Changhai Composite Materials' Earnings Growth And 4.6% ROE

As you can see, Jiangsu Changhai Composite Materials' ROE looks pretty weak. Even when compared to the industry average of 6.4%, the ROE figure is pretty disappointing. Although, we can see that Jiangsu Changhai Composite Materials saw a modest net income growth of 10% over the past five years. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place.

We then compared Jiangsu Changhai Composite Materials' 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 6.2% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. 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 Jiangsu Changhai Composite Materials is trading on a high P/E or a low P/E, relative to its industry.

Is Jiangsu Changhai Composite Materials Making Efficient Use Of Its Profits?

In Jiangsu Changhai Composite Materials' case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 11% (or a retention ratio of 89%), which suggests that the company is investing most of its profits to grow its business.

Besides, Jiangsu Changhai Composite Materials has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.

Summary

Overall, we feel that Jiangsu Changhai Composite Materials certainly does have some positive factors to consider. 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. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.