Most readers would already be aware that Prinx Chengshan Holdings' (HKG:1809) stock increased significantly by 28% over the past three months. Since the market usually pay for a company's long-term fundamentals, we decided to study the company's key performance indicators to see if they could be influencing the market. In this article, we decided to focus on Prinx Chengshan Holdings' ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How Do You 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 Prinx Chengshan Holdings is:

19% = CN¥1.0b ÷ CN¥5.4b (Based on the trailing twelve months to December 2023).

The 'return' refers to a company's earnings over the last year. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.19.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Prinx Chengshan Holdings' Earnings Growth And 19% ROE

To begin with, Prinx Chengshan Holdings seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 7.5%. Yet, Prinx Chengshan Holdings has posted measly growth of 4.5% over the past five years. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.

We then performed a comparison between Prinx Chengshan Holdings' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 4.1% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 Prinx Chengshan Holdings is trading on a high P/E or a low P/E, relative to its industry.

Is Prinx Chengshan Holdings Using Its Retained Earnings Effectively?

A low three-year median payout ratio of 24% (implying that the company retains the remaining 76% of its income) suggests that Prinx Chengshan Holdings is retaining most of its profits. However, the low earnings growth number doesn't reflect this fact. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Moreover, Prinx Chengshan Holdings has been paying dividends for five years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

Overall, we are quite pleased with Prinx Chengshan Holdings' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see a good amount of growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. Our risks dashboard will have the 1 risk we have identified for Prinx Chengshan Holdings.

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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.