Canggang Railway (HKG:2169) has had a great run on the share market with its stock up by a significant 118% over the last three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on Canggang Railway's ROE.

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.

See our latest analysis for Canggang Railway

How Do You Calculate Return On Equity?

Return on equity can be calculated by using the formula:

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

So, based on the above formula, the ROE for Canggang Railway is:

9.5% = CN¥73m ÷ CN¥774m (Based on the trailing twelve months to June 2023).

The 'return' is the income the business earned over the last year. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.09.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 Canggang Railway's Earnings Growth And 9.5% ROE

On the face of it, Canggang Railway's ROE is not much to talk about. However, its ROE is similar to the industry average of 7.9%, so we won't completely dismiss the company. But then again, Canggang Railway's five year net income shrunk at a rate of 2.3%. Bear in mind, the company does have a slightly low ROE. Hence, this goes some way in explaining the shrinking earnings.

From the 2.0% decline reported by the industry in the same period, we infer that Canggang Railway and its industry are both shrinking at a similar rate.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Canggang Railway fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Canggang Railway Using Its Retained Earnings Effectively?

Looking at its three-year median payout ratio of 45% (or a retention ratio of 55%) which is pretty normal, Canggang Railway'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.

Only recently, Canggang Railway stated paying a dividend. This likely means that the management might have concluded that its shareholders have a strong preference for dividends.

Conclusion

In total, we're a bit ambivalent about Canggang Railway's performance. 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 2 risks we have identified for Canggang Railway 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.