Central China New Life (HKG:9983) has had a rough three months with its share price down 18%. However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Central China New Life'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Central China New Life

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 Central China New Life is:

21% = CN¥653m ÷ CN¥3.1b (Based on the trailing twelve months to December 2021).

The 'return' is the income the business earned over the last year. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.21 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Central China New Life's Earnings Growth And 21% ROE

To begin with, Central China New Life seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 7.4%. This probably laid the ground for Central China New Life's significant 41% 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. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Central China New Life'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 8.7%.

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. Is Central China New Life fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Central China New Life Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 58% (implying that it keeps only 42% of profits) for Central China New Life suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.

While Central China New Life has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 55% of its profits over the next three years. Still, forecasts suggest that Central China New Life's future ROE will rise to 30% even though the the company's payout ratio is not expected to change by much.

Conclusion

In total, we are pretty happy with Central China New Life's performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.