Xinling Electrical (SZSE:301388) has had a great run on the share market with its stock up by a significant 25% over the last week. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Particularly, we will be paying attention to Xinling Electrical's ROE today.

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 Is ROE Calculated?

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 Xinling Electrical is:

5.2% = CN¥52m ÷ CN¥1.0b (Based on the trailing twelve months to September 2023).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.05 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.

Xinling Electrical's Earnings Growth And 5.2% ROE

On the face of it, Xinling Electrical's ROE is not much to talk about. Next, when compared to the average industry ROE of 7.1%, the company's ROE leaves us feeling even less enthusiastic. Therefore, Xinling Electrical's flat earnings over the past five years can possibly be explained by the low ROE amongst other factors.

As a next step, we compared Xinling Electrical's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 14% in the same period.

Earnings growth is a huge factor in stock valuation. 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. Is Xinling Electrical fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Xinling Electrical Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 93% (meaning, the company retains only 7.0% of profits) for Xinling Electrical suggests that the company's earnings growth was miniscule as a result of paying out a majority of its earnings.

Additionally, Xinling Electrical started paying a dividend only recently. So it looks like the management must have perceived that shareholders favor dividends over earnings growth.

Summary

On the whole, Xinling Electrical's performance is quite a big let-down. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. Up till now, we've only made a short study of the company's growth data. You can do your own research on Xinling Electrical and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.

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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.