It is hard to get excited after looking at Guoguang ElectricLtd.Chengdu's (SHSE:688776) recent performance, when its stock has declined 30% 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. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Specifically, we decided to study Guoguang ElectricLtd.Chengdu's ROE in this article.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

How Is ROE Calculated?

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 Guoguang ElectricLtd.Chengdu is:

5.0% = CN¥94m ÷ CN¥1.9b (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.05 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

Guoguang ElectricLtd.Chengdu's Earnings Growth And 5.0% ROE

When you first look at it, Guoguang ElectricLtd.Chengdu's ROE doesn't look that attractive. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 6.7%. Therefore, Guoguang ElectricLtd.Chengdu's flat earnings over the past five years can possibly be explained by the low ROE amongst other factors.

We then compared Guoguang ElectricLtd.Chengdu's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 11% in the same 5-year period, which is a bit concerning.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Guoguang ElectricLtd.Chengdu is trading on a high P/E or a low P/E, relative to its industry.

Is Guoguang ElectricLtd.Chengdu Efficiently Re-investing Its Profits?

Guoguang ElectricLtd.Chengdu's low three-year median payout ratio of 24%, (meaning the company retains76% of profits) should mean that the company is retaining most of its earnings and consequently, should see higher growth than it has reported.

Only recently, Guoguang ElectricLtd.Chengdu started paying a dividend. This means that the management might have concluded that its shareholders prefer dividends over earnings growth.

Summary

On the whole, we feel that the performance shown by Guoguang ElectricLtd.Chengdu 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. So far, we've only made a quick discussion around the company's earnings growth. You can do your own research on Guoguang ElectricLtd.Chengdu 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.