With its stock down 9.3% over the past month, it is easy to disregard Contec Medical SystemsLtd (SZSE:300869). However, stock prices are usually driven by a company's financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Contec Medical SystemsLtd's ROE today.

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.

View our latest analysis for Contec Medical SystemsLtd

How To 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 Contec Medical SystemsLtd is:

10% = CN¥217m ÷ CN¥2.1b (Based on the trailing twelve months to September 2023).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.10 in profit.

Why Is ROE Important For 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.

A Side By Side comparison of Contec Medical SystemsLtd's Earnings Growth And 10% ROE

When you first look at it, Contec Medical SystemsLtd's ROE doesn't look that attractive. However, its ROE is similar to the industry average of 9.3%, so we won't completely dismiss the company. Even so, Contec Medical SystemsLtd has shown a fairly decent growth in its net income which grew at a rate of 9.9%. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that Contec Medical SystemsLtd's reported growth was lower than the industry growth of 16% over the last few years, 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. Is Contec Medical SystemsLtd fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Contec Medical SystemsLtd Making Efficient Use Of Its Profits?

Contec Medical SystemsLtd has a low three-year median payout ratio of 24%, meaning that the company retains the remaining 76% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Moreover, Contec Medical SystemsLtd is determined to keep sharing its profits with shareholders which we infer from its long history of three years of paying a dividend.

Conclusion

In total, it does look like Contec Medical SystemsLtd has some positive aspects to its business. 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. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 2 risks we have identified for Contec Medical SystemsLtd visit our risks dashboard for free.

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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.