Zhengyuan Geomatics GroupLtd (SHSE:688509) has had a great run on the share market with its stock up by a significant 20% over the last month. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Specifically, we decided to study Zhengyuan Geomatics GroupLtd'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Zhengyuan Geomatics GroupLtd

How Is ROE Calculated?

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 Zhengyuan Geomatics GroupLtd is:

4.6% = CN¥78m ÷ CN¥1.7b (Based on the trailing twelve months to March 2022).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.05 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.

Zhengyuan Geomatics GroupLtd's Earnings Growth And 4.6% ROE

It is quite clear that Zhengyuan Geomatics GroupLtd's ROE is rather low. Not just that, even compared to the industry average of 7.6%, the company's ROE is entirely unremarkable. For this reason, Zhengyuan Geomatics GroupLtd's five year net income decline of 7.1% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

That being said, we compared Zhengyuan Geomatics GroupLtd's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 8.9% in the same period.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Zhengyuan Geomatics GroupLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Zhengyuan Geomatics GroupLtd Using Its Retained Earnings Effectively?

When we piece together Zhengyuan Geomatics GroupLtd's low three-year median payout ratio of 22% (where it is retaining 78% of its profits), calculated for the last three-year period, we are puzzled by the lack of growth. This typically shouldn't be the case when a company is retaining most of its earnings. So there could be some other explanations in that regard. For example, the company's business may be deteriorating.

Conclusion

Overall, we have mixed feelings about Zhengyuan Geomatics GroupLtd. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. To know the 2 risks we have identified for Zhengyuan Geomatics GroupLtd visit our risks dashboard for free.

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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.