With its stock down 4.9% over the past three months, it is easy to disregard China Railway Construction Heavy Industry (SHSE:688425). 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 China Railway Construction Heavy Industry's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out 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:

10% = CN¥1.7b ÷ CN¥16b (Based on the trailing twelve months to September 2023).

The 'return' is the income the business earned 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¥0.10 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company's earnings growth potential. 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 10% ROE

At first glance, China Railway Construction Heavy Industry's ROE doesn't look very promising. However, the fact that the company's ROE is higher than the average industry ROE of 7.5%, is definitely interesting. However, China Railway Construction Heavy Industry's five year net income growth was quite low averaging at only 3.4%. Bear in mind, the company does have a low ROE. It is just that the industry ROE is lower. Therefore, the low growth in earnings could also be the result of this.

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 11% over the last few years, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. 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 China Railway Construction Heavy Industry is trading on a high P/E or a low P/E, relative to its industry.

Is China Railway Construction Heavy Industry Making Efficient Use Of Its Profits?

Despite having a moderate three-year median payout ratio of 29% (implying that the company retains the remaining 71% of its income), China Railway Construction Heavy Industry's earnings growth was quite low. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

In addition, China Railway Construction Heavy Industry only recently started paying a dividend so the management must have decided the shareholders prefer dividends over earnings growth.

Conclusion

On the whole, we do feel that China Railway Construction Heavy Industry has some positive attributes. However, while the company does have a decent ROE and a high profit retention, its earnings growth number is quite disappointing. This suggests that there might be some external threat to the business, that's hampering growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.