Chengdu Bright Eye Hospital (SZSE:301239) has had a rough three months with its share price down 24%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Chengdu Bright Eye Hospital'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.

Check out our latest analysis for Chengdu Bright Eye Hospital

How Do You Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Chengdu Bright Eye Hospital is:

11% = CN¥252m ÷ CN¥2.4b (Based on the trailing twelve months to September 2023).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.11 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Chengdu Bright Eye Hospital's Earnings Growth And 11% ROE

When you first look at it, Chengdu Bright Eye Hospital's ROE doesn't look that attractive. However, the fact that the company's ROE is higher than the average industry ROE of 7.9%, is definitely interesting. Especially when you consider Chengdu Bright Eye Hospital's exceptional 27% net income growth over the past five years. That being said, the company does have a slightly low ROE to begin with, just that it is higher than the industry average. Hence, there might be some other aspects that are causing earnings to grow. For example, it is possible that the broader industry is going through a high growth phase, or that the company has a low payout ratio.

As a next step, we compared Chengdu Bright Eye Hospital'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 7.0%.

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 Chengdu Bright Eye Hospital is trading on a high P/E or a low P/E, relative to its industry.

Is Chengdu Bright Eye Hospital Making Efficient Use Of Its Profits?

Chengdu Bright Eye Hospital's three-year median payout ratio to shareholders is 8.3%, which is quite low. This implies that the company is retaining 92% of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

While Chengdu Bright Eye Hospital has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend.

Conclusion

In total, we are pretty happy with Chengdu Bright Eye Hospital's performance. Specifically, we like that it has been reinvesting a high portion of its profits at a moderate rate of return, resulting in earnings expansion. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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.