Chongqing Changan Automobile (SZSE:000625) has had a great run on the share market with its stock up by a significant 18% over the last three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Chongqing Changan Automobile's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

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 Changan Automobile is:

4.6% = CN¥3.5b ÷ CN¥75b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.05 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.

Chongqing Changan Automobile's Earnings Growth And 4.6% ROE

As you can see, Chongqing Changan Automobile's ROE looks pretty weak. Further, we noted that the company's ROE is similar to the industry average of 4.6%. Moreover, we are quite pleased to see that Chongqing Changan Automobile's net income grew significantly at a rate of 38% over the last five years. Considering the low ROE, it is quite possible that there might also be some other aspects that are positively influencing the company's earnings growth. 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.

As a next step, we compared Chongqing Changan Automobile'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 13%.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is 000625 worth today? The intrinsic value infographic in our free research report helps visualize whether 000625 is currently mispriced by the market.

Is Chongqing Changan Automobile Using Its Retained Earnings Effectively?

Chongqing Changan Automobile's three-year median payout ratio is a pretty moderate 30%, meaning the company retains 71% of its income. So it seems that Chongqing Changan Automobile is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Moreover, Chongqing Changan Automobile 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 31% of its profits over the next three years. However, Chongqing Changan Automobile's ROE is predicted to rise to 7.2% despite there being no anticipated change in its payout ratio.

Conclusion

Overall, we feel that Chongqing Changan Automobile 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. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.