It is hard to get excited after looking at Jiuzhitang's (SZSE:000989) recent performance, when its stock has declined 11% over the past three months. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. Particularly, we will be paying attention to Jiuzhitang's ROE today.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Jiuzhitang

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 Jiuzhitang is:

6.0% = CN¥233m ÷ CN¥3.9b (Based on the trailing twelve months to June 2023).

The 'return' is the yearly profit. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.06 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Jiuzhitang's Earnings Growth And 6.0% ROE

When you first look at it, Jiuzhitang's ROE doesn't look that attractive. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 9.1%. For this reason, Jiuzhitang's five year net income decline of 3.4% 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 Jiuzhitang's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 10% in the same period. This is quite worrisome.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Jiuzhitang's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Jiuzhitang Making Efficient Use Of Its Profits?

Jiuzhitang's high three-year median payout ratio of 116% suggests that the company is depleting its resources to keep up its dividend payments, and this shows in its shrinking earnings. Its usually very hard to sustain dividend payments that are higher than reported profits. Our risks dashboard should have the 3 risks we have identified for Jiuzhitang.

Moreover, Jiuzhitang has been paying dividends for seven years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking.

Conclusion

Overall, we would be extremely cautious before making any decision on Jiuzhitang. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. Up till now, we've only made a short study of the company's growth data. So it may be worth checking this free detailed graph of Jiuzhitang's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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.