Jiangsu Tongli Risheng Machinery (SHSE:605286) has had a rough month with its share price down 16%. However, stock prices are usually driven by a company's financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Jiangsu Tongli Risheng Machinery's ROE in this article.

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.

View our latest analysis for Jiangsu Tongli Risheng Machinery

How Do You Calculate Return On Equity?

Return on equity 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 Jiangsu Tongli Risheng Machinery is:

8.1% = CN¥145m ÷ CN¥1.8b (Based on the trailing twelve months to September 2022).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.08 in profit.

Why Is ROE Important For 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 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.

A Side By Side comparison of Jiangsu Tongli Risheng Machinery's Earnings Growth And 8.1% ROE

At first glance, Jiangsu Tongli Risheng Machinery's ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.9%. On the other hand, Jiangsu Tongli Risheng Machinery reported a moderate 10% net income growth over the past five years. Given the slightly low ROE, it is likely that there could be some other aspects that are driving 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.

We then performed a comparison between Jiangsu Tongli Risheng Machinery's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 12% in the same period.

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. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Jiangsu Tongli Risheng Machinery is trading on a high P/E or a low P/E, relative to its industry.

Is Jiangsu Tongli Risheng Machinery Making Efficient Use Of Its Profits?

In Jiangsu Tongli Risheng Machinery's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 13% (or a retention ratio of 87%), which suggests that the company is investing most of its profits to grow its business.

While Jiangsu Tongli Risheng Machinery 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.

Summary

Overall, we feel that Jiangsu Tongli Risheng Machinery certainly does have some positive factors to consider. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.