Shenzhen New Land Tool Planning & Architectural Design (SZSE:300778) has had a great run on the share market with its stock up by a significant 32% over the last week. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study Shenzhen New Land Tool Planning & Architectural Design's ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How Do You 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 Shenzhen New Land Tool Planning & Architectural Design is:

1.2% = CN¥18m ÷ CN¥1.5b (Based on the trailing twelve months to September 2023).

The 'return' is the profit 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¥0.01 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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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 Shenzhen New Land Tool Planning & Architectural Design's Earnings Growth And 1.2% ROE

It is quite clear that Shenzhen New Land Tool Planning & Architectural Design's ROE is rather low. Not just that, even compared to the industry average of 6.3%, the company's ROE is entirely unremarkable. Therefore, it might not be wrong to say that the five year net income decline of 18% seen by Shenzhen New Land Tool Planning & Architectural Design was possibly a result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

So, as a next step, we compared Shenzhen New Land Tool Planning & Architectural Design's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 3.2% over the last few years.

Earnings growth is an important metric to consider when valuing a stock. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Shenzhen New Land Tool Planning & Architectural Design's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shenzhen New Land Tool Planning & Architectural Design Making Efficient Use Of Its Profits?

Despite having a normal three-year median payout ratio of 41% (where it is retaining 59% of its profits), Shenzhen New Land Tool Planning & Architectural Design has seen a decline in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, Shenzhen New Land Tool Planning & Architectural Design has paid dividends over a period of four years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Conclusion

In total, we're a bit ambivalent about Shenzhen New Land Tool Planning & Architectural Design's performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. You can see the 6 risks we have identified for Shenzhen New Land Tool Planning & Architectural Design by visiting our risks dashboard for free on our platform here.

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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.