It is hard to get excited after looking at Chengdu KSW TechnologiesLtd's (SHSE:688283) recent performance, when its stock has declined 42% over the past three months. 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. In this article, we decided to focus on Chengdu KSW TechnologiesLtd'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.

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 Chengdu KSW TechnologiesLtd is:

9.3% = CN¥87m ÷ CN¥933m (Based on the trailing twelve months to December 2023).

The 'return' is the amount earned after tax 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¥0.09.

Why Is ROE Important For 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.

Chengdu KSW TechnologiesLtd's Earnings Growth And 9.3% ROE

At first glance, Chengdu KSW TechnologiesLtd's ROE doesn't look very promising. Although a closer study shows that the company's ROE is higher than the industry average of 6.3% which we definitely can't overlook. Even more so after seeing Chengdu KSW TechnologiesLtd's exceptional 31% net income growth over the past five years. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. Therefore, the growth in earnings could also be the result of other factors. For example, it is possible that the broader industry is going through a high growth phase, or that the company has a low payout ratio.

We then compared Chengdu KSW TechnologiesLtd's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 13% in the same 5-year period.

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Chengdu KSW TechnologiesLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Chengdu KSW TechnologiesLtd Using Its Retained Earnings Effectively?

Chengdu KSW TechnologiesLtd has a really low three-year median payout ratio of 9.3%, meaning that it has the remaining 91% left over to reinvest into its business. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

While Chengdu KSW TechnologiesLtd has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 5.7% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 14%, over the same period.

Conclusion

On the whole, we feel that Chengdu KSW TechnologiesLtd's performance has been quite good. 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. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.