Most readers would already be aware that Shenzhen Zhilai Sci and Tech's (SZSE:300771) stock increased significantly by 29% over the past three months. 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 Shenzhen Zhilai Sci and Tech'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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Shenzhen Zhilai Sci and Tech

How To Calculate Return On Equity?

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 Shenzhen Zhilai Sci and Tech is:

6.0% = CN¥120m ÷ CN¥2.0b (Based on the trailing twelve months to March 2023).

The 'return' is the profit over the last twelve months. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.06.

What Has ROE Got To Do With 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. 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.

Shenzhen Zhilai Sci and Tech's Earnings Growth And 6.0% ROE

On the face of it, Shenzhen Zhilai Sci and Tech's 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 7.7% either. Given the circumstances, the significant decline in net income by 3.7% seen by Shenzhen Zhilai Sci and Tech over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.

However, when we compared Shenzhen Zhilai Sci and Tech's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 13% 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). This then helps them determine if the stock is placed for a bright or bleak future. Is Shenzhen Zhilai Sci and Tech fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Shenzhen Zhilai Sci and Tech Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 28% (where it is retaining 72% of its profits), Shenzhen Zhilai Sci and Tech has seen a decline in earnings as we saw above. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Additionally, Shenzhen Zhilai Sci and Tech has paid dividends over a period of four years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Conclusion

Overall, we have mixed feelings about Shenzhen Zhilai Sci and Tech. 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. Our risks dashboard would have the 2 risks we have identified for Shenzhen Zhilai Sci and Tech.

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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.