Most readers would already be aware that Jiangxi Hongdu Aviation Industry's (SHSE:600316) stock increased significantly by 14% 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. In this article, we decided to focus on Jiangxi Hongdu Aviation Industry's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Jiangxi Hongdu Aviation Industry is:

0.7% = CN¥38m ÷ CN¥5.3b (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¥0.01 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Jiangxi Hongdu Aviation Industry's Earnings Growth And 0.7% ROE

It is quite clear that Jiangxi Hongdu Aviation Industry's ROE is rather low. Even compared to the average industry ROE of 5.1%, the company's ROE is quite dismal. Given the circumstances, the significant decline in net income by 16% seen by Jiangxi Hongdu Aviation Industry over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

That being said, we compared Jiangxi Hongdu Aviation Industry's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 13% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Jiangxi Hongdu Aviation Industry's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Jiangxi Hongdu Aviation Industry Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 33% (that is, a retention ratio of 67%), the fact that Jiangxi Hongdu Aviation Industry'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, Jiangxi Hongdu Aviation Industry has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

Overall, we have mixed feelings about Jiangxi Hongdu Aviation Industry. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. 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 3 risks we have identified for Jiangxi Hongdu Aviation Industry 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.