It is hard to get excited after looking at Zhuhai CosMX Battery's (SHSE:688772) recent performance, when its stock has declined 34% 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. Particularly, we will be paying attention to Zhuhai CosMX Battery's ROE today.

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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Zhuhai CosMX Battery

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 Zhuhai CosMX Battery is:

12% = CN¥741m ÷ CN¥6.4b (Based on the trailing twelve months to March 2022).

The 'return' is the income the business earned over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.12.

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. 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. 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.

Zhuhai CosMX Battery's Earnings Growth And 12% ROE

At first glance, Zhuhai CosMX Battery seems to have a decent ROE. Especially when compared to the industry average of 8.7% the company's ROE looks pretty impressive. This certainly adds some context to Zhuhai CosMX Battery's exceptional 40% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

We then compared Zhuhai CosMX Battery's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 14% in the same period.

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 Zhuhai CosMX Battery is trading on a high P/E or a low P/E, relative to its industry.

Is Zhuhai CosMX Battery Using Its Retained Earnings Effectively?

Zhuhai CosMX Battery has a really low three-year median payout ratio of 22%, meaning that it has the remaining 78% left over to reinvest into its business. So it looks like Zhuhai CosMX Battery is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 29% over the next three years. Still, forecasts suggest that Zhuhai CosMX Battery's future ROE will rise to 20% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.

Conclusion

In total, we are pretty happy with Zhuhai CosMX Battery's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.