Most readers would already be aware that Gree Electric Appliances of Zhuhai's (SZSE:000651) stock increased significantly by 13% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Gree Electric Appliances of Zhuhai's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

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 Gree Electric Appliances of Zhuhai is:

21% = CN¥25b ÷ CN¥117b (Based on the trailing twelve months to September 2023).

The 'return' is the profit over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.21 in profit.

What Has ROE Got To Do With 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.

Gree Electric Appliances of Zhuhai's Earnings Growth And 21% ROE

To start with, Gree Electric Appliances of Zhuhai's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 11%. Given the circumstances, we can't help but wonder why Gree Electric Appliances of Zhuhai saw little to no growth in the past five years. Therefore, there could be some other aspects that could potentially be preventing the company from growing. These include low earnings retention or poor allocation of capital.

Next, on comparing with the industry net income growth, we found that the industry grew its earnings by 8.0% over the last few years.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for 000651? You can find out in our latest intrinsic value infographic research report.

Is Gree Electric Appliances of Zhuhai Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 72% (implying that the company keeps only 28% of its income) of its business to reinvest into its business), most of Gree Electric Appliances of Zhuhai's profits are being paid to shareholders, which explains the absence of growth in earnings.

Additionally, Gree Electric Appliances of Zhuhai 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 47% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.

Summary

In total, it does look like Gree Electric Appliances of Zhuhai has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.