It is hard to get excited after looking at Dazhong Transportation (Group)'s (SHSE:600611) recent performance, when its stock has declined 12% over the past three months. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Specifically, we decided to study Dazhong Transportation (Group)'s ROE in this article.

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

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 Dazhong Transportation (Group) is:

3.1% = CN¥319m ÷ CN¥10b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.03 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. 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 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.

Dazhong Transportation (Group)'s Earnings Growth And 3.1% ROE

It is hard to argue that Dazhong Transportation (Group)'s ROE is much good in and of itself. Even when compared to the industry average of 4.4%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 36% seen by Dazhong Transportation (Group) over the last five years is not surprising. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.

As a next step, we compared Dazhong Transportation (Group)'s performance with the industry and found thatDazhong Transportation (Group)'s performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 0.6% in the same period, which is a slower than the company.

Earnings growth is an important metric to consider when valuing a stock. 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. If you're wondering about Dazhong Transportation (Group)'s's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Dazhong Transportation (Group) Making Efficient Use Of Its Profits?

Looking at its three-year median payout ratio of 40% (or a retention ratio of 60%) which is pretty normal, Dazhong Transportation (Group)'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. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

In addition, Dazhong Transportation (Group) has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Conclusion

On the whole, we feel that the performance shown by Dazhong Transportation (Group) 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. 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 4 risks we have identified for Dazhong Transportation (Group) 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.