Most readers would already be aware that Tongding Interconnection Information's (SZSE:002491) stock increased significantly by 41% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Tongding Interconnection Information's ROE in this article.

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. 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 Tongding Interconnection Information is:

1.5% = CN¥38m ÷ CN¥2.5b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.02 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. 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 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 Tongding Interconnection Information's Earnings Growth And 1.5% ROE

It is quite clear that Tongding Interconnection Information's ROE is rather low. Even when compared to the industry average of 5.6%, the ROE figure is pretty disappointing. In spite of this, Tongding Interconnection Information was able to grow its net income considerably, at a rate of 58% in the last five years. Therefore, there could be other reasons behind this growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Tongding Interconnection Information's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 12%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Tongding Interconnection Information is trading on a high P/E or a low P/E, relative to its industry.

Is Tongding Interconnection Information Using Its Retained Earnings Effectively?

Given that Tongding Interconnection Information doesn't pay any regular dividends to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.

Conclusion

On the whole, we do feel that Tongding Interconnection Information has some positive attributes. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard will have the 1 risk we have identified for Tongding Interconnection Information.

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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.