It is hard to get excited after looking at Zhe Jiang Taihua New Material's (SHSE:603055) recent performance, when its stock has declined 14% over the past month. However, stock prices are usually driven by a company's financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Zhe Jiang Taihua New Material's ROE.

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 Zhe Jiang Taihua New Material

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 Zhe Jiang Taihua New Material is:

11% = CN¥441m ÷ CN¥3.9b (Based on the trailing twelve months to June 2022).

The 'return' is the yearly profit. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.11 in profit.

Why Is ROE Important For 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 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.

Zhe Jiang Taihua New Material's Earnings Growth And 11% ROE

To begin with, Zhe Jiang Taihua New Material seems to have a respectable ROE. On comparing with the average industry ROE of 7.7% the company's ROE looks pretty remarkable. However, we are curious as to how the high returns still resulted in flat growth for Zhe Jiang Taihua New Material in the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

We then compared Zhe Jiang Taihua New Material's net income growth with the industry and found that the average industry growth rate was 5.6% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Zhe Jiang Taihua New Material's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Zhe Jiang Taihua New Material Making Efficient Use Of Its Profits?

Despite having a normal three-year median payout ratio of 31% (implying that the company keeps 69% of its income) over the last three years, Zhe Jiang Taihua New Material has seen a negligible amount of growth in earnings as we saw above. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, Zhe Jiang Taihua New Material 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.

Summary

Overall, we feel that Zhe Jiang Taihua New Material certainly does have some positive factors to consider. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.