It is hard to get excited after looking at Shanghai Geoharbour Construction Group's (SHSE:605598) recent performance, when its stock has declined 44% over the past three months. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on Shanghai Geoharbour Construction Group's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

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 Shanghai Geoharbour Construction Group is:

9.5% = CN¥163m ÷ CN¥1.7b (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.10.

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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Shanghai Geoharbour Construction Group's Earnings Growth And 9.5% ROE

On the face of it, Shanghai Geoharbour Construction Group's ROE is not much to talk about. Although a closer study shows that the company's ROE is higher than the industry average of 7.6% which we definitely can't overlook. Still, Shanghai Geoharbour Construction Group's net income growth of 4.9% over the past five years was mediocre at best. Bear in mind, the company does have a low ROE. It is just that the industry ROE is lower. Hence, this goes some way in explaining the low earnings growth.

Next, on comparing with the industry net income growth, we found that Shanghai Geoharbour Construction Group's reported growth was lower than the industry growth of 8.4% 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. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Shanghai Geoharbour Construction Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shanghai Geoharbour Construction Group Making Efficient Use Of Its Profits?

Shanghai Geoharbour Construction Group has a low three-year median payout ratio of 8.8% (meaning, the company keeps the remaining 91% of profits) which means that the company is retaining more of its earnings. However, the low earnings growth number doesn't reflect this fact. 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, Shanghai Geoharbour Construction Group only recently started paying a dividend so the management must have decided the shareholders prefer dividends over earnings growth.

Summary

Overall, we feel that Shanghai Geoharbour Construction Group certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a moderate ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.