Jiangsu Rainbow Heavy Industries (SZSE:002483) has had a great run on the share market with its stock up by a significant 19% over the last month. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. Specifically, we decided to study Jiangsu Rainbow Heavy Industries' ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

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 Jiangsu Rainbow Heavy Industries is:

5.3% = CN¥235m ÷ CN¥4.4b (Based on the trailing twelve months to June 2024).

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

Jiangsu Rainbow Heavy Industries' Earnings Growth And 5.3% ROE

On the face of it, Jiangsu Rainbow Heavy Industries' ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 7.0% either. For this reason, Jiangsu Rainbow Heavy Industries' five year net income decline of 10% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared Jiangsu Rainbow Heavy Industries' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 8.7% in the same period. This is quite worrisome.

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. Is Jiangsu Rainbow Heavy Industries fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Jiangsu Rainbow Heavy Industries Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 45% (that is, a retention ratio of 55%), the fact that Jiangsu Rainbow Heavy Industries' earnings have shrunk is quite puzzling. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, Jiangsu Rainbow Heavy Industries 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

On the whole, we feel that the performance shown by Jiangsu Rainbow Heavy Industries can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.