Ruijie Networks' (SZSE:301165) stock is up by a considerable 5.5% over the past month. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to Ruijie Networks' ROE today.

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 To Calculate Return On Equity?

Return on equity 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 Ruijie Networks is:

10% = CN¥415m ÷ CN¥4.1b (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.10 in profit.

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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company's earnings growth potential. 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.

A Side By Side comparison of Ruijie Networks' Earnings Growth And 10% ROE

At first glance, Ruijie Networks' ROE doesn't look very promising. However, the fact that the its ROE is quite higher to the industry average of 7.2% doesn't go unnoticed by us. However, Ruijie Networks has seen a flattish net income growth over the past five years, which is not saying much. Remember, the company's ROE is a bit low to begin with, just that it is higher than the industry average. Therefore, the low to flat growth in earnings could also be the result of this.

Next, on comparing with the industry net income growth, we found that the industry grew its earnings by 11% over the last few years.

Earnings growth is an important metric to consider when valuing a stock. 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. 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 Ruijie Networks is trading on a high P/E or a low P/E, relative to its industry.

Is Ruijie Networks Making Efficient Use Of Its Profits?

Ruijie Networks has a high three-year median payout ratio of 79% (or a retention ratio of 21%), meaning that the company is paying most of its profits as dividends to its shareholders. This does go some way in explaining why there's been no growth in its earnings.

In addition, Ruijie Networks only recently started paying a dividend so the management must have decided the shareholders prefer dividends over earnings growth.

Summary

On the whole, we feel that the performance shown by Ruijie Networks can be open to many interpretations. On the one hand, the company does have a decent rate of return, however, its earnings growth number is quite disappointing and as discussed earlier, the low retained earnings is hampering the growth. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.