It is hard to get excited after looking at Fujian Longking's (SHSE:600388) recent performance, when its stock has declined 17% over the past three months. 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. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Specifically, we decided to study Fujian Longking's 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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

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 Fujian Longking is:

6.4% = CN¥520m ÷ CN¥8.1b (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings 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¥0.06 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.

Fujian Longking's Earnings Growth And 6.4% ROE

When you first look at it, Fujian Longking's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 6.8%. But then again, Fujian Longking's five year net income shrunk at a rate of 3.5%. 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 Fujian Longking'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.

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). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Fujian Longking's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Fujian Longking Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 32% (that is, a retention ratio of 68%), the fact that Fujian Longking's earnings have shrunk is quite puzzling. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Moreover, Fujian Longking has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Conclusion

In total, we're a bit ambivalent about Fujian Longking's performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its 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. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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