Most readers would already be aware that Canggang Railway's (HKG:2169) stock increased significantly by 66% over the past month. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. In this article, we decided to focus on Canggang Railway's ROE.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How To Calculate Return On Equity?

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 Canggang Railway is:

6.7% = CN¥53m ÷ CN¥801m (Based on the trailing twelve months to June 2024).

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

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company's earnings growth potential. 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.

A Side By Side comparison of Canggang Railway's Earnings Growth And 6.7% ROE

When you first look at it, Canggang Railway's ROE doesn't look that attractive. However, its ROE is similar to the industry average of 6.7%, so we won't completely dismiss the company. Having said that, Canggang Railway's five year net income decline rate was 3.9%. Bear in mind, the company does have a slightly low ROE. So that's what might be causing earnings growth to shrink.

Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate of 2.4% over the last few years, we found that Canggang Railway's performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Canggang Railway's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Canggang Railway Making Efficient Use Of Its Profits?

In spite of a normal three-year median payout ratio of 41% (that is, a retention ratio of 59%), the fact that Canggang Railway's earnings have shrunk is quite puzzling. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Moreover, Canggang Railway has been paying dividends for three years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking.

Conclusion

On the whole, we feel that the performance shown by Canggang Railway can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. 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. You can see the 1 risk we have identified for Canggang Railway by visiting our risks dashboard for free on our platform here.

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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.