Shanghai Dazhong Public Utilities(Group)Ltd's (SHSE:600635) stock is up by a considerable 40% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Particularly, we will be paying attention to Shanghai Dazhong Public Utilities(Group)Ltd's ROE today.

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 To 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 Shanghai Dazhong Public Utilities(Group)Ltd is:

2.2% = CN¥216m ÷ CN¥9.9b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.02.

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. 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.

Shanghai Dazhong Public Utilities(Group)Ltd's Earnings Growth And 2.2% ROE

It is hard to argue that Shanghai Dazhong Public Utilities(Group)Ltd's ROE is much good in and of itself. Even when compared to the industry average of 9.3%, the ROE figure is pretty disappointing. For this reason, Shanghai Dazhong Public Utilities(Group)Ltd's five year net income decline of 41% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared Shanghai Dazhong Public Utilities(Group)Ltd's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 10.0% in the same period. This is quite worrisome.

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. If you're wondering about Shanghai Dazhong Public Utilities(Group)Ltd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shanghai Dazhong Public Utilities(Group)Ltd Efficiently Re-investing Its Profits?

Looking at its three-year median payout ratio of 30% (or a retention ratio of 70%) which is pretty normal, Shanghai Dazhong Public Utilities(Group)Ltd's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, Shanghai Dazhong Public Utilities(Group)Ltd has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Summary

In total, we're a bit ambivalent about Shanghai Dazhong Public Utilities(Group)Ltd's performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. You can see the 5 risks we have identified for Shanghai Dazhong Public Utilities(Group)Ltd 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.