Shenzhen Zhaowei Machinery & Electronics' (SZSE:003021) stock is up by a considerable 13% over the past week. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Specifically, we decided to study Shenzhen Zhaowei Machinery & Electronics' ROE in this article.

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 Is ROE Calculated?

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 Shenzhen Zhaowei Machinery & Electronics is:

6.6% = CN¥207m ÷ CN¥3.1b (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.07 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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company's earnings growth potential. 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 Shenzhen Zhaowei Machinery & Electronics' Earnings Growth And 6.6% ROE

When you first look at it, Shenzhen Zhaowei Machinery & Electronics' ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 6.9%. But then again, Shenzhen Zhaowei Machinery & Electronics' five year net income shrunk at a rate of 19%. Bear in mind, the company does have a slightly low ROE. Therefore, the decline in earnings could also be the result of this.

However, when we compared Shenzhen Zhaowei Machinery & Electronics' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 13% in the same period. This is quite worrisome.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Shenzhen Zhaowei Machinery & Electronics''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shenzhen Zhaowei Machinery & Electronics Making Efficient Use Of Its Profits?

Looking at its three-year median payout ratio of 29% (or a retention ratio of 71%) which is pretty normal, Shenzhen Zhaowei Machinery & Electronics' 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. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, Shenzhen Zhaowei Machinery & Electronics has paid dividends over a period of three years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Conclusion

In total, we're a bit ambivalent about Shenzhen Zhaowei Machinery & Electronics' performance. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.