Most readers would already be aware that Zhejiang Zhongcheng Packing Material's (SZSE:002522) stock increased significantly by 11% over the past month. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to Zhejiang Zhongcheng Packing Material'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.

See our latest analysis for Zhejiang Zhongcheng Packing Material

How Do You Calculate Return On Equity?

ROE 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 Zhejiang Zhongcheng Packing Material is:

7.5% = CN¥159m ÷ CN¥2.1b (Based on the trailing twelve months to March 2022).

The 'return' is the income the business earned over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.07 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

A Side By Side comparison of Zhejiang Zhongcheng Packing Material's Earnings Growth And 7.5% ROE

At first glance, Zhejiang Zhongcheng Packing Material's ROE doesn't look very promising. Next, when compared to the average industry ROE of 10%, the company's ROE leaves us feeling even less enthusiastic. Despite this, surprisingly, Zhejiang Zhongcheng Packing Material saw an exceptional 26% net income growth over the past five years. Therefore, there could be other reasons behind this 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.

As a next step, we compared Zhejiang Zhongcheng Packing Material'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 19%.

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). This then helps them determine if the stock is placed for a bright or bleak future. Is Zhejiang Zhongcheng Packing Material fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Zhejiang Zhongcheng Packing Material Using Its Retained Earnings Effectively?

Zhejiang Zhongcheng Packing Material's three-year median payout ratio is a pretty moderate 42%, meaning the company retains 58% of its income. By the looks of it, the dividend is well covered and Zhejiang Zhongcheng Packing Material is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Additionally, Zhejiang Zhongcheng Packing Material has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders.

Summary

In total, it does look like Zhejiang Zhongcheng Packing Material has some positive aspects to its business. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard will have the 1 risk we have identified for Zhejiang Zhongcheng Packing Material.

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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.