Shenzhen Guangju Energy (SZSE:000096) has had a great run on the share market with its stock up by a significant 24% over the last three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. Particularly, we will be paying attention to Shenzhen Guangju Energy'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Shenzhen Guangju Energy

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 Shenzhen Guangju Energy is:

2.3% = CN¥67m ÷ CN¥2.9b (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¥0.02.

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. 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.

Shenzhen Guangju Energy's Earnings Growth And 2.3% ROE

As you can see, Shenzhen Guangju Energy's ROE looks pretty weak. Even compared to the average industry ROE of 15%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 22% seen by Shenzhen Guangju Energy was possibly a result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.

However, when we compared Shenzhen Guangju Energy's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 15% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Shenzhen Guangju Energy is trading on a high P/E or a low P/E, relative to its industry.

Is Shenzhen Guangju Energy Making Efficient Use Of Its Profits?

Shenzhen Guangju Energy's low three-year median payout ratio of 9.1% (or a retention ratio of 91%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, Shenzhen Guangju Energy has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Conclusion

Overall, we have mixed feelings about Shenzhen Guangju Energy. 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. Our risks dashboard would have the 5 risks we have identified for Shenzhen Guangju Energy.

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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.