Most readers would already be aware that Chongqing Zongshen Power MachineryLtd's (SZSE:001696) stock increased significantly by 89% over the past three months. 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. In this article, we decided to focus on Chongqing Zongshen Power MachineryLtd'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. 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 Chongqing Zongshen Power MachineryLtd is:

7.1% = CN¥372m ÷ CN¥5.2b (Based on the trailing twelve months to December 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¥0.07 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. 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. 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.

Chongqing Zongshen Power MachineryLtd's Earnings Growth And 7.1% ROE

On the face of it, Chongqing Zongshen Power MachineryLtd's ROE is not much to talk about. However, given that the company's ROE is similar to the average industry ROE of 7.8%, we may spare it some thought. Still, Chongqing Zongshen Power MachineryLtd has seen a flat net income growth over the past five years. Bear in mind, the company's ROE is not very high. So that could also be one of the reasons behind the company's flat growth in earnings.

As a next step, we compared Chongqing Zongshen Power MachineryLtd's net income growth with the industry and discovered that the industry saw an average growth of 6.4% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Chongqing Zongshen Power MachineryLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Chongqing Zongshen Power MachineryLtd Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 68% (meaning, the company retains only 32% of profits) for Chongqing Zongshen Power MachineryLtd suggests that the company's earnings growth was miniscule as a result of paying out a majority of its earnings.

Moreover, Chongqing Zongshen Power MachineryLtd has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

In total, we would have a hard think before deciding on any investment action concerning Chongqing Zongshen Power MachineryLtd. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. So far, we've only made a quick discussion around the company's earnings growth. To gain further insights into Chongqing Zongshen Power MachineryLtd's past profit growth, check out this visualization 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.