With its stock down 6.8% over the past week, it is easy to disregard Zhejiang FORE Intelligent TechnologyLtd (SZSE:301368). It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Stock prices are usually driven by a company's financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on Zhejiang FORE Intelligent TechnologyLtd'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 Zhejiang FORE Intelligent TechnologyLtd is:

2.1% = CN¥21m ÷ CN¥975m (Based on the trailing twelve months to March 2024).

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¥0.02 in profit.

What Is The Relationship Between ROE And 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. 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.

Zhejiang FORE Intelligent TechnologyLtd's Earnings Growth And 2.1% ROE

It is quite clear that Zhejiang FORE Intelligent TechnologyLtd's ROE is rather low. Even compared to the average industry ROE of 6.9%, the company's ROE is quite dismal. For this reason, Zhejiang FORE Intelligent TechnologyLtd's five year net income decline of 20% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.

However, when we compared Zhejiang FORE Intelligent TechnologyLtd's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 9.5% in the same period. This is quite worrisome.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. 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 Zhejiang FORE Intelligent TechnologyLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Zhejiang FORE Intelligent TechnologyLtd Efficiently Re-investing Its Profits?

Looking at its three-year median payout ratio of 38% (or a retention ratio of 62%) which is pretty normal, Zhejiang FORE Intelligent TechnologyLtd's 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. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Additionally, Zhejiang FORE Intelligent TechnologyLtd started paying a dividend only recently. So it looks like the management may have perceived that shareholders favor dividends even though earnings have been in decline.

Conclusion

On the whole, we feel that the performance shown by Zhejiang FORE Intelligent TechnologyLtd can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. To know the 4 risks we have identified for Zhejiang FORE Intelligent TechnologyLtd 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com