It is hard to get excited after looking at China Railway Construction Heavy Industry's (SHSE:688425) recent performance, when its stock has declined 5.6% over the past three months. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on China Railway Construction Heavy Industry's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for China Railway Construction Heavy Industry

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 China Railway Construction Heavy Industry is:

12% = CN¥1.8b ÷ 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¥0.12 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. 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

China Railway Construction Heavy Industry's Earnings Growth And 12% ROE

To begin with, China Railway Construction Heavy Industry seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 8.1%. This certainly adds some context to China Railway Construction Heavy Industry's decent 7.5% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that China Railway Construction Heavy Industry's reported growth was lower than the industry growth of 12% in the same period, which is not something we like to see.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about China Railway Construction Heavy Industry's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is China Railway Construction Heavy Industry Efficiently Re-investing Its Profits?

With a three-year median payout ratio of 27% (implying that the company retains 73% of its profits), it seems that China Railway Construction Heavy Industry is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Conclusion

In total, we are pretty happy with China Railway Construction Heavy Industry's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see a good amount of growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. Our risks dashboard would have the 2 risks we have identified for China Railway Construction Heavy Industry.

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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.