It is hard to get excited after looking at Zhejiang Chint Electrics' (SHSE:601877) recent performance, when its stock has declined 3.6% over the past month. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Zhejiang Chint Electrics' ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

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 Zhejiang Chint Electrics is:

9.9% = CN¥4.8b ÷ CN¥48b (Based on the trailing twelve months to March 2024).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.10 in profit.

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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

A Side By Side comparison of Zhejiang Chint Electrics' Earnings Growth And 9.9% ROE

When you first look at it, Zhejiang Chint Electrics' ROE doesn't look that attractive. However, the fact that the its ROE is quite higher to the industry average of 6.9% doesn't go unnoticed by us. However, Zhejiang Chint Electrics has seen a flattish net income growth over the past five years, which is not saying much. Remember, the company's ROE is a bit low to begin with, just that it is higher than the industry average. Therefore, the low to flat growth in earnings could also be the result of this.

Next, on comparing with the industry net income growth, we found that the industry grew its earnings by 12% 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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Zhejiang Chint Electrics is trading on a high P/E or a low P/E, relative to its industry.

Is Zhejiang Chint Electrics Efficiently Re-investing Its Profits?

Zhejiang Chint Electrics has a low three-year median payout ratio of 22% (or a retention ratio of 78%) but the negligible earnings growth number doesn't reflect this as high growth usually follows high profit retention.

Additionally, Zhejiang Chint Electrics 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, it does look like Zhejiang Chint Electrics has some positive aspects to its business. However, while the company does have a decent ROE and a high profit retention, its earnings growth number is quite disappointing. This suggests that there might be some external threat to the business, that's hampering 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com