Changzhou Aohong Electronics (SHSE:605058) has had a rough week with its share price down 13%. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Stock prices are usually driven by a company's financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Particularly, we will be paying attention to Changzhou Aohong Electronics' ROE today.

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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Changzhou Aohong Electronics is:

7.2% = CN¥122m ÷ CN¥1.7b (Based on the trailing twelve months to September 2024).

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

What Is The Relationship Between ROE And 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

Changzhou Aohong Electronics' Earnings Growth And 7.2% ROE

At first glance, Changzhou Aohong Electronics' ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 6.3%. Having said that, Changzhou Aohong Electronics' net income growth over the past five years is more or less flat. Remember, the company's ROE is not particularly great to begin with. Hence, this provides some context to the flat earnings growth seen by the company.

We then compared Changzhou Aohong Electronics' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 3.9% in the same 5-year period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. 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 Changzhou Aohong Electronics is trading on a high P/E or a low P/E, relative to its industry.

Is Changzhou Aohong Electronics Making Efficient Use Of Its Profits?

Despite having a normal three-year median payout ratio of 32% (implying that the company keeps 68% of its income) over the last three years, Changzhou Aohong Electronics has seen a negligible amount of growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, Changzhou Aohong Electronics has paid dividends over a period of four years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Conclusion

On the whole, we feel that the performance shown by Changzhou Aohong Electronics 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 Changzhou Aohong Electronics' past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.