Shenzhen Tellus Holding (SZSE:000025) has had a great run on the share market with its stock up by a significant 34% over the last three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. In this article, we decided to focus on Shenzhen Tellus Holding's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

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 Shenzhen Tellus Holding is:

8.0% = CN¥146m ÷ CN¥1.8b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.08 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. 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.

Shenzhen Tellus Holding's Earnings Growth And 8.0% ROE

At first glance, Shenzhen Tellus Holding's ROE doesn't look very promising. However, its ROE is similar to the industry average of 7.3%, so we won't completely dismiss the company. Having said that, Shenzhen Tellus Holding's five year net income decline rate was 7.5%. Bear in mind, the company does have a slightly low ROE. Hence, this goes some way in explaining the shrinking earnings.

That being said, we compared Shenzhen Tellus Holding's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 5.9% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Shenzhen Tellus Holding's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shenzhen Tellus Holding Efficiently Re-investing Its Profits?

When we piece together Shenzhen Tellus Holding's low three-year median payout ratio of 10% (where it is retaining 90% of its profits), calculated for the last three-year period, we are puzzled by the lack of growth. This typically shouldn't be the case when a company is retaining most of its earnings. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.

In addition, Shenzhen Tellus Holding has been paying dividends over a period of five years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.

Summary

On the whole, we feel that the performance shown by Shenzhen Tellus Holding can be open to many interpretations. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. Our risks dashboard will have the 1 risk we have identified for Shenzhen Tellus Holding.

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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.