With its stock down 25% over the past month, it is easy to disregard Red Avenue New Materials Group (SHSE:603650). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Red Avenue New Materials Group's ROE today.

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.

Check out our latest analysis for Red Avenue New Materials Group

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 Red Avenue New Materials Group is:

12% = CN¥348m ÷ CN¥2.8b (Based on the trailing twelve months to December 2021).

The 'return' is the income the business earned over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.12.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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.

Red Avenue New Materials Group's Earnings Growth And 12% ROE

At first glance, Red Avenue New Materials Group seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 11%. Despite the moderate return on equity, Red Avenue New Materials Group has posted a net income growth of 4.8% over the past five years. A few likely reasons that could be keeping earnings growth low are - the company has a high payout ratio or the business has allocated capital poorly, for instance.

We then compared Red Avenue New Materials Group's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 18% in the same period, which is a bit concerning.

Earnings growth is a huge factor in stock valuation. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Red Avenue New Materials Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Red Avenue New Materials Group Efficiently Re-investing Its Profits?

While Red Avenue New Materials Group has a decent three-year median payout ratio of 48% (or a retention ratio of 52%), it has seen very little growth in earnings. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

In addition, Red Avenue New Materials Group has been paying dividends over a period of three years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Summary

On the whole, we do feel that Red Avenue New Materials Group has some positive attributes. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. 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.