Zhejiang TongLi Transmission Technology (SZSE:301255) has had a great run on the share market with its stock up by a significant 23% over the last month. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study Zhejiang TongLi Transmission Technology's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How Is ROE Calculated?

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 Zhejiang TongLi Transmission Technology is:

6.8% = CN¥69m ÷ CN¥1.0b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.07 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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.

Zhejiang TongLi Transmission Technology's Earnings Growth And 6.8% ROE

When you first look at it, Zhejiang TongLi Transmission Technology's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.0%. On the other hand, Zhejiang TongLi Transmission Technology reported a moderate 11% net income growth over the past five years. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings 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 Zhejiang TongLi Transmission Technology's growth is quite high when compared to the industry average growth of 8.7% in the same period, which is great to see.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Zhejiang TongLi Transmission Technology is trading on a high P/E or a low P/E, relative to its industry.

Is Zhejiang TongLi Transmission Technology Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 68% (or a retention ratio of 32%) for Zhejiang TongLi Transmission Technology suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

While Zhejiang TongLi Transmission Technology has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend.

Summary

On the whole, we do feel that Zhejiang TongLi Transmission Technology has some positive attributes. That is, quite an impressive growth in earnings. However, the low profit retention means that the company's earnings growth could have been higher, had it been reinvesting a higher portion of its profits. So far, we've only made a quick discussion around the company's earnings growth. So it may be worth checking this free detailed graph of Zhejiang TongLi Transmission Technology's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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.