Most readers would already be aware that Guoguang ElectricLtd.Chengdu's (SHSE:688776) stock increased significantly by 50% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study Guoguang ElectricLtd.Chengdu's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How Do You 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 Guoguang ElectricLtd.Chengdu is:

4.2% = CN¥79m ÷ CN¥1.9b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.04 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. 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.

Guoguang ElectricLtd.Chengdu's Earnings Growth And 4.2% ROE

As you can see, Guoguang ElectricLtd.Chengdu's ROE looks pretty weak. Even when compared to the industry average of 6.4%, the ROE figure is pretty disappointing. Therefore, Guoguang ElectricLtd.Chengdu's flat earnings over the past five years can possibly be explained by the low ROE amongst other factors.

As a next step, we compared Guoguang ElectricLtd.Chengdu's net income growth with the industry and discovered that the industry saw an average growth of 10% in the same period.

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. Doing so will help them establish if the stock's future looks promising or ominous. 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 Guoguang ElectricLtd.Chengdu is trading on a high P/E or a low P/E, relative to its industry.

Is Guoguang ElectricLtd.Chengdu Making Efficient Use Of Its Profits?

Guoguang ElectricLtd.Chengdu's low three-year median payout ratio of 25%, (meaning the company retains75% of profits) should mean that the company is retaining most of its earnings and consequently, should see higher growth than it has reported.

In addition, Guoguang ElectricLtd.Chengdu has been paying dividends over a period of three years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Summary

On the whole, we feel that the performance shown by Guoguang ElectricLtd.Chengdu 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. Up till now, we've only made a short study of the company's growth data. So it may be worth checking this free detailed graph of Guoguang ElectricLtd.Chengdu'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.