China Machinery Huanyu Certification and Inspection (SZSE:301508) has had a rough three months with its share price down 22%. 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 China Machinery Huanyu Certification and Inspection'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

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 China Machinery Huanyu Certification and Inspection is:

7.6% = CN¥152m ÷ CN¥2.0b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.08.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of China Machinery Huanyu Certification and Inspection's Earnings Growth And 7.6% ROE

At first glance, China Machinery Huanyu Certification and Inspection's ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 6.4%. Even so, China Machinery Huanyu Certification and Inspection has shown a fairly decent growth in its net income which grew at a rate of 17%. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that China Machinery Huanyu Certification and Inspection's growth is quite high when compared to the industry average growth of 0.6% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about China Machinery Huanyu Certification and Inspection's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is China Machinery Huanyu Certification and Inspection Efficiently Re-investing Its Profits?

China Machinery Huanyu Certification and Inspection has a significant three-year median payout ratio of 53%, meaning that it is left with only 47% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Summary

In total, it does look like China Machinery Huanyu Certification and Inspection has some positive aspects to its business. While no doubt its earnings growth is pretty substantial, we do feel that the reinvestment rate is pretty low, meaning, the earnings growth number could have been significantly higher had the company been retaining more of its profits. So far, we've only made a quick discussion around the company's earnings growth. You can do your own research on China Machinery Huanyu Certification and Inspection and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.

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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.