With its stock down 19% over the past three months, it is easy to disregard Zhonghang Electronic Measuring InstrumentsLtd (SZSE:300114). It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Stock prices are usually driven by a company's financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on Zhonghang Electronic Measuring InstrumentsLtd's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Zhonghang Electronic Measuring InstrumentsLtd is:

4.1% = CN¥99m ÷ CN¥2.4b (Based on the trailing twelve months to September 2023).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.04 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

A Side By Side comparison of Zhonghang Electronic Measuring InstrumentsLtd's Earnings Growth And 4.1% ROE

As you can see, Zhonghang Electronic Measuring InstrumentsLtd's ROE looks pretty weak. Even compared to the average industry ROE of 6.7%, the company's ROE is quite dismal. Hence, the flat earnings seen by Zhonghang Electronic Measuring InstrumentsLtd over the past five years could probably be the result of it having a lower ROE.

Next, on comparing with the industry net income growth, we found that Zhonghang Electronic Measuring InstrumentsLtd's reported growth was lower than the industry growth of 11% over the last few years, which is not something we like to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is Zhonghang Electronic Measuring InstrumentsLtd fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Zhonghang Electronic Measuring InstrumentsLtd Efficiently Re-investing Its Profits?

Zhonghang Electronic Measuring InstrumentsLtd's low three-year median payout ratio of 10%, (meaning the company retains90% of profits) should mean that the company is retaining most of its earnings and consequently, should see higher growth than it has reported.

Additionally, Zhonghang Electronic Measuring InstrumentsLtd has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Summary

Overall, we have mixed feelings about Zhonghang Electronic Measuring InstrumentsLtd. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.