Most readers would already be aware that Nanjing Canatal Data-Centre Environmental Tech's (SHSE:603912) stock increased significantly by 55% over the past three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Specifically, we decided to study Nanjing Canatal Data-Centre Environmental Tech's ROE in this article.

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 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 Nanjing Canatal Data-Centre Environmental Tech is:

1.5% = CN¥27m ÷ CN¥1.9b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.01.

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. 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 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.

Nanjing Canatal Data-Centre Environmental Tech's Earnings Growth And 1.5% ROE

As you can see, Nanjing Canatal Data-Centre Environmental Tech's ROE looks pretty weak. Even when compared to the industry average of 6.3%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 26% seen by Nanjing Canatal Data-Centre Environmental Tech over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared Nanjing Canatal Data-Centre Environmental Tech's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 7.3% in the same period. This is quite worrisome.

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Nanjing Canatal Data-Centre Environmental Tech is trading on a high P/E or a low P/E, relative to its industry.

Is Nanjing Canatal Data-Centre Environmental Tech Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 100% (implying that -0.3% of the profits are retained), most of Nanjing Canatal Data-Centre Environmental Tech's profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. Our risks dashboard should have the 3 risks we have identified for Nanjing Canatal Data-Centre Environmental Tech.

Moreover, Nanjing Canatal Data-Centre Environmental Tech has been paying dividends for seven 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.

Summary

Overall, we would be extremely cautious before making any decision on Nanjing Canatal Data-Centre Environmental Tech. The low ROE, combined with the fact that the company is paying out almost if not all, of its profits as dividends, has resulted in the lack or absence of growth in its earnings. So far, we've only made a quick discussion around the company's earnings growth. To gain further insights into Nanjing Canatal Data-Centre Environmental Tech's past profit growth, check out this visualization 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.