It is hard to get excited after looking at Greentown Service Group's (HKG:2869) recent performance, when its stock has declined 35% over the past three months. However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Greentown Service Group's ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Greentown Service Group

How To 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 Greentown Service Group is:

9.3% = CN¥703m ÷ CN¥7.6b (Based on the trailing twelve months to June 2022).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each HK$1 of shareholders' capital it has, the company made HK$0.09 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.

Greentown Service Group's Earnings Growth And 9.3% 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 6.8% which we definitely can't overlook. Consequently, this likely laid the ground for the decent growth of 17% seen over the past five years by Greentown Service Group. 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. 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.

Next, on comparing with the industry net income growth, we found that Greentown Service Group's growth is quite high when compared to the industry average growth of 5.6% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Greentown Service Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Greentown Service Group Making Efficient Use Of Its Profits?

Greentown Service Group has a healthy combination of a moderate three-year median payout ratio of 38% (or a retention ratio of 62%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Moreover, Greentown Service Group is determined to keep sharing its profits with shareholders which we infer from its long history of five years of paying a dividend. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 45% of its profits over the next three years. Still, forecasts suggest that Greentown Service Group's future ROE will rise to 18% even though the the company's payout ratio is not expected to change by much.

Summary

Overall, we are quite pleased with Greentown Service Group's performance. In particular, it's great to see that the company has seen significant growth in its earnings backed by a respectable ROE and a high reinvestment rate. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.