With its stock down 15% over the past month, it is easy to disregard Jiangsu Linyang Energy (SHSE:601222). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on Jiangsu Linyang Energy's ROE.

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.

See our latest analysis for Jiangsu Linyang Energy

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 Jiangsu Linyang Energy is:

5.5% = CN¥805m ÷ CN¥15b (Based on the trailing twelve months to June 2022).

The 'return' is the yearly profit. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.06 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. 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 Jiangsu Linyang Energy's Earnings Growth And 5.5% ROE

At first glance, Jiangsu Linyang Energy's ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 8.8%. Although, we can see that Jiangsu Linyang Energy saw a modest net income growth of 6.9% over the past five years. So, there might 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.

Next, on comparing with the industry net income growth, we found that Jiangsu Linyang Energy's reported growth was lower than the industry growth of 14% in the same period, which is not something we like to see.

Earnings growth is a huge factor in stock valuation. 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. Has the market priced in the future outlook for 601222? You can find out in our latest intrinsic value infographic research report.

Is Jiangsu Linyang Energy Making Efficient Use Of Its Profits?

In Jiangsu Linyang Energy's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 19% (or a retention ratio of 81%), which suggests that the company is investing most of its profits to grow its business.

Moreover, Jiangsu Linyang Energy is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 6.0% over the next three years. As a result, the expected drop in Jiangsu Linyang Energy's payout ratio explains the anticipated rise in the company's future ROE to 8.4%, over the same period.

Conclusion

On the whole, we do feel that Jiangsu Linyang Energy has some positive attributes. That is, a decent growth in earnings backed by a high rate of reinvestment. However, we do feel that that earnings growth could have been higher if the business were to improve on the low ROE rate. Especially given how the company is reinvesting a huge chunk of its profits. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.