With its stock down 32% over the past three months, it is easy to disregard Changhong Meiling (SZSE:000521). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Changhong Meiling'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. 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?

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 Changhong Meiling is:

13% = CN¥828m ÷ CN¥6.3b (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.13 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Changhong Meiling's Earnings Growth And 13% ROE

At first glance, Changhong Meiling seems to have a decent ROE. On comparing with the average industry ROE of 9.6% the company's ROE looks pretty remarkable. Probably as a result of this, Changhong Meiling was able to see an impressive net income growth of 64% over the last five years. However, there could also be other causes behind this growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Changhong Meiling's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 5.7%.

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). 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 Changhong Meiling's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Changhong Meiling Using Its Retained Earnings Effectively?

Changhong Meiling's three-year median payout ratio is a pretty moderate 39%, meaning the company retains 61% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Changhong Meiling is reinvesting its earnings efficiently.

Moreover, Changhong Meiling is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Conclusion

Overall, we are quite pleased with Changhong Meiling's 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 substantial growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.

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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.