It is hard to get excited after looking at Mengtian Home Group's (SHSE:603216) recent performance, when its stock has declined 30% over the past three months. However, stock prices are usually driven by a company's financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Mengtian Home Group's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Do You Calculate Return On Equity?

ROE 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 Mengtian Home Group is:

7.7% = CN¥135m ÷ CN¥1.7b (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.08 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. 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.

Mengtian Home Group's Earnings Growth And 7.7% ROE

At first glance, Mengtian Home Group's ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 7.8%, we may spare it some thought. Even so, Mengtian Home Group has shown a fairly decent growth in its net income which grew at a rate of 6.4%. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

Next, on comparing Mengtian Home Group's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 6.0% over the last few years.

Earnings growth is a huge factor in stock valuation. 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. 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 Mengtian Home Group is trading on a high P/E or a low P/E, relative to its industry.

Is Mengtian Home Group Making Efficient Use Of Its Profits?

Mengtian Home Group has a healthy combination of a moderate three-year median payout ratio of 25% (or a retention ratio of 75%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

While Mengtian Home Group has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend.

Conclusion

On the whole, we do feel that Mengtian Home Group has some positive attributes. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 1 risk we have identified for Mengtian Home Group visit our risks dashboard for free.

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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.