With its stock down 11% over the past three months, it is easy to disregard Greentown Service Group (HKG:2869). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Greentown Service Group's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

How To Calculate Return On Equity?

Return on equity 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 Greentown Service Group is:

8.6% = CN¥698m ÷ CN¥8.1b (Based on the trailing twelve months to June 2023).

The 'return' refers to a company's earnings over the last year. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.09 in profit.

What Has ROE Got To Do With 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. 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.

Greentown Service Group's Earnings Growth And 8.6% ROE

On the face of it, Greentown Service Group's ROE is not much to talk about. Although a closer study shows that the company's ROE is higher than the industry average of 6.1% which we definitely can't overlook. This probably goes some way in explaining Greentown Service Group's moderate 8.0% growth over the past five years amongst other factors. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. Therefore, the growth in earnings could also be the result of other factors. E.g the company has a low payout ratio or could belong to a high growth industry.

As a next step, we compared Greentown Service Group'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 2.6%.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is Greentown Service Group fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Greentown Service Group Efficiently Re-investing Its Profits?

With a three-year median payout ratio of 46% (implying that the company retains 54% of its profits), it seems that Greentown Service Group is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Moreover, Greentown Service Group is determined to keep sharing its profits with shareholders which we infer from its long history of seven years of paying a dividend. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 49%. Still, forecasts suggest that Greentown Service Group's future ROE will rise to 13% even though the the company's payout ratio is not expected to change by much.

Summary

On the whole, we feel that Greentown Service Group's performance has been quite good. Specifically, we like that it has been reinvesting a high portion of its profits at a moderate rate of return, resulting in earnings expansion. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.