It is hard to get excited after looking at Chinasoft International's (HKG:354) recent performance, when its stock has declined 22% over the past three months. 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 Chinasoft International's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Chinasoft International

How Do You Calculate Return On Equity?

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 Chinasoft International is:

9.8% = CN¥1.2b ÷ CN¥12b (Based on the trailing twelve months to June 2022).

The 'return' refers to a company's earnings over the last year. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.10 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 Chinasoft International's Earnings Growth And 9.8% ROE

To start with, Chinasoft International's ROE looks acceptable. On comparing with the average industry ROE of 6.9% the company's ROE looks pretty remarkable. This probably laid the ground for Chinasoft International's moderate 17% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that Chinasoft International's growth is quite high when compared to the industry average growth of 3.5% in the same period, which is great 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. Is Chinasoft International fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Chinasoft International Using Its Retained Earnings Effectively?

In Chinasoft International's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 6.3% (or a retention ratio of 94%), which suggests that the company is investing most of its profits to grow its business.

Moreover, Chinasoft International is determined to keep sharing its profits with shareholders which we infer from its long history of five years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 6.3%. Still, forecasts suggest that Chinasoft International's future ROE will rise to 13% even though the the company's payout ratio is not expected to change by much.

Conclusion

On the whole, we feel that Chinasoft International's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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.