With its stock down 20% over the past three months, it is easy to disregard Zhejiang Rongtai Electric MaterialLtd (SHSE:603119). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Zhejiang Rongtai Electric MaterialLtd's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

How To 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 Zhejiang Rongtai Electric MaterialLtd is:

9.8% = CN¥157m ÷ CN¥1.6b (Based on the trailing twelve months to September 2023).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.10 in profit.

What Has ROE Got To Do With 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. 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.

Zhejiang Rongtai Electric MaterialLtd's Earnings Growth And 9.8% ROE

On the face of it, Zhejiang Rongtai Electric MaterialLtd's ROE is not much to talk about. Although a closer study shows that the company's ROE is higher than the industry average of 7.2% which we definitely can't overlook. Even more so after seeing Zhejiang Rongtai Electric MaterialLtd's exceptional 38% net income growth over the past five years. That being said, the company does have a slightly low ROE to begin with, just that it is higher than the industry average. Hence, there might be some other aspects that are causing earnings to grow. E.g the company has a low payout ratio or could belong to a high growth industry.

Next, on comparing with the industry net income growth, we found that Zhejiang Rongtai Electric MaterialLtd's growth is quite high when compared to the industry average growth of 14% in the same period, which is great to see.

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. Doing so will help them establish if the stock's future looks promising or ominous. Is Zhejiang Rongtai Electric MaterialLtd fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Zhejiang Rongtai Electric MaterialLtd Using Its Retained Earnings Effectively?

Zhejiang Rongtai Electric MaterialLtd's ' three-year median payout ratio is on the lower side at 7.1% implying that it is retaining a higher percentage (93%) of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Conclusion

Overall, we are quite pleased with Zhejiang Rongtai Electric MaterialLtd's performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth.

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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.