With its stock down 24% over the past three months, it is easy to disregard Zhejiang Extek Technology (SZSE:301399). 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 Zhejiang Extek Technology'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Zhejiang Extek Technology

How To 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 Zhejiang Extek Technology is:

8.8% = CN¥113m ÷ CN¥1.3b (Based on the trailing twelve months to September 2023).

The 'return' is the income the business earned over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.09.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

Zhejiang Extek Technology's Earnings Growth And 8.8% ROE

When you first look at it, Zhejiang Extek Technology's ROE doesn't look that attractive. However, its ROE is similar to the industry average of 7.5%, so we won't completely dismiss the company. Moreover, we are quite pleased to see that Zhejiang Extek Technology's net income grew significantly at a rate of 27% over the last 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.

As a next step, we compared Zhejiang Extek Technology's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 11%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Zhejiang Extek Technology's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Zhejiang Extek Technology Making Efficient Use Of Its Profits?

The three-year median payout ratio for Zhejiang Extek Technology is 44%, which is moderately low. The company is retaining the remaining 56%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Zhejiang Extek Technology is reinvesting its earnings efficiently.

Conclusion

Overall, we feel that Zhejiang Extek Technology 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. 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. Our risks dashboard would have the 2 risks we have identified for Zhejiang Extek Technology.

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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.