Chongqing Three Gorges Water Conservancy and Electric Power (SHSE:600116) has had a rough month with its share price down 5.0%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Chongqing Three Gorges Water Conservancy and Electric Power's ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. 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 Chongqing Three Gorges Water Conservancy and Electric Power is:

4.7% = CN¥540m ÷ CN¥12b (Based on the trailing twelve months to September 2024).

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

What Is The Relationship Between ROE And 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Chongqing Three Gorges Water Conservancy and Electric Power's Earnings Growth And 4.7% ROE

It is quite clear that Chongqing Three Gorges Water Conservancy and Electric Power's ROE is rather low. Even compared to the average industry ROE of 6.9%, the company's ROE is quite dismal. Chongqing Three Gorges Water Conservancy and Electric Power was still able to see a decent net income growth of 6.8% over the past five years. Therefore, the growth in earnings could probably have been caused by other variables. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

Next, on comparing with the industry net income growth, we found that Chongqing Three Gorges Water Conservancy and Electric Power's growth is quite high when compared to the industry average growth of 0.4% in the same period, which is great to see.

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. 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 Chongqing Three Gorges Water Conservancy and Electric Power is trading on a high P/E or a low P/E, relative to its industry.

Is Chongqing Three Gorges Water Conservancy and Electric Power Using Its Retained Earnings Effectively?

Chongqing Three Gorges Water Conservancy and Electric Power has a healthy combination of a moderate three-year median payout ratio of 47% (or a retention ratio of 53%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Besides, Chongqing Three Gorges Water Conservancy and Electric Power has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.

Conclusion

In total, it does look like Chongqing Three Gorges Water Conservancy and Electric Power has some positive aspects to its business. 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. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.