With its stock down 18% over the past three months, it is easy to disregard Changzhou Tenglong AutoPartsCo.Ltd (SHSE:603158). We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. In this article, we decided to focus on Changzhou Tenglong AutoPartsCo.Ltd's ROE.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How To Calculate Return On Equity?

Return on equity 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 Changzhou Tenglong AutoPartsCo.Ltd is:

8.4% = CN¥188m ÷ CN¥2.2b (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¥0.08 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. 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.

Changzhou Tenglong AutoPartsCo.Ltd's Earnings Growth And 8.4% ROE

When you first look at it, Changzhou Tenglong AutoPartsCo.Ltd's ROE doesn't look that attractive. However, its ROE is similar to the industry average of 7.3%, so we won't completely dismiss the company. Having said that, Changzhou Tenglong AutoPartsCo.Ltd's net income growth over the past five years is more or less flat. Remember, the company's ROE is not particularly great to begin with. So that could also be one of the reasons behind the company's flat growth in earnings.

As a next step, we compared Changzhou Tenglong AutoPartsCo.Ltd'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 3.8% in the same period.

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. 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 Changzhou Tenglong AutoPartsCo.Ltd is trading on a high P/E or a low P/E, relative to its industry.

Is Changzhou Tenglong AutoPartsCo.Ltd Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 27% (or a retention ratio of 73%), Changzhou Tenglong AutoPartsCo.Ltd hasn't seen much growth in its earnings. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, Changzhou Tenglong AutoPartsCo.Ltd has been paying dividends for eight years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Conclusion

Overall, we have mixed feelings about Changzhou Tenglong AutoPartsCo.Ltd. 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. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.