Zhejiang Zomax Transmission (SHSE:603767) has had a great run on the share market with its stock up by a significant 35% over the last three months. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. In this article, we decided to focus on Zhejiang Zomax Transmission's ROE.

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 To Calculate Return On Equity?

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 Zhejiang Zomax Transmission is:

3.9% = CN¥57m ÷ CN¥1.4b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.04 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. 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. 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 Zhejiang Zomax Transmission's Earnings Growth And 3.9% ROE

It is hard to argue that Zhejiang Zomax Transmission's ROE is much good in and of itself. Even compared to the average industry ROE of 8.3%, the company's ROE is quite dismal. Hence, the flat earnings seen by Zhejiang Zomax Transmission over the past five years could probably be the result of it having a lower ROE.

Next, on comparing with the industry net income growth, we found that Zhejiang Zomax Transmission's reported growth was lower than the industry growth of 9.2% over the last few years, which is not something we like 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 Zhejiang Zomax Transmission is trading on a high P/E or a low P/E, relative to its industry.

Is Zhejiang Zomax Transmission Using Its Retained Earnings Effectively?

Zhejiang Zomax Transmission has a three-year median payout ratio as high as 148% meaning that the company is paying a dividend which is beyond its means. The absence in growth is therefore not surprising. Paying a dividend higher than reported profits is not a sustainable move. This is quite a risky position to be in.

Additionally, Zhejiang Zomax Transmission has paid dividends over a period of seven years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Summary

In total, we would have a hard think before deciding on any investment action concerning Zhejiang Zomax Transmission. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. You can do your own research on Zhejiang Zomax Transmission 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.