Sichuan Changhong ElectricLtd (SHSE:600839) has had a great run on the share market with its stock up by a significant 206% over the last three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Sichuan Changhong ElectricLtd's ROE today.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Is ROE Calculated?

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 Sichuan Changhong ElectricLtd is:

7.0% = CN¥1.7b ÷ CN¥24b (Based on the trailing twelve months to September 2024).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.07 in profit.

What Has ROE Got To Do With 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. 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.

A Side By Side comparison of Sichuan Changhong ElectricLtd's Earnings Growth And 7.0% ROE

When you first look at it, Sichuan Changhong ElectricLtd's ROE doesn't look that attractive. Next, when compared to the average industry ROE of 9.2%, the company's ROE leaves us feeling even less enthusiastic. However, we we're pleasantly surprised to see that Sichuan Changhong ElectricLtd grew its net income at a significant rate of 44% in the last five years. Therefore, there could be other reasons behind this 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 Sichuan Changhong ElectricLtd's growth is quite high when compared to the industry average growth of 8.5% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Sichuan Changhong ElectricLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Sichuan Changhong ElectricLtd Using Its Retained Earnings Effectively?

Sichuan Changhong ElectricLtd's three-year median payout ratio is a pretty moderate 30%, meaning the company retains 70% of its income. By the looks of it, the dividend is well covered and Sichuan Changhong ElectricLtd is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Moreover, Sichuan Changhong ElectricLtd 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.

Summary

Overall, we feel that Sichuan Changhong ElectricLtd certainly does have some positive factors to consider. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard would have the 3 risks we have identified for Sichuan Changhong ElectricLtd.

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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.