It is hard to get excited after looking at Chengdu Zhimingda Electronics' (SHSE:688636) recent performance, when its stock has declined 34% over the past three months. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Particularly, we will be paying attention to Chengdu Zhimingda Electronics' ROE today.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Chengdu Zhimingda Electronics is:

8.0% = CN¥86m ÷ CN¥1.1b (Based on the trailing twelve months to March 2024).

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

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Chengdu Zhimingda Electronics' Earnings Growth And 8.0% ROE

At first glance, Chengdu Zhimingda Electronics' ROE doesn't look very promising. However, its ROE is similar to the industry average of 6.7%, so we won't completely dismiss the company. However, Chengdu Zhimingda Electronics has seen a flattish net income growth over the past five years, which is not saying much. Bear in mind, the company's ROE is not very high. Hence, this provides some context to the flat earnings growth seen by the company.

Next, on comparing with the industry net income growth, we found that the industry grew its earnings by 14% over the last few years.

Earnings growth is a huge factor in stock valuation. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Chengdu Zhimingda Electronics''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Chengdu Zhimingda Electronics Using Its Retained Earnings Effectively?

Chengdu Zhimingda Electronics has a low three-year median payout ratio of 13% (or a retention ratio of 87%) but the negligible earnings growth number doesn't reflect this as high growth usually follows high profit retention.

Only recently, Chengdu Zhimingda Electronics started paying a dividend. This means that the management might have concluded that its shareholders prefer dividends over earnings growth.

Conclusion

Overall, we have mixed feelings about Chengdu Zhimingda Electronics. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.

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