With its stock down 43% over the past three months, it is easy to disregard Chengdu Leejun Industrial (SZSE:002651). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Chengdu Leejun Industrial'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Chengdu Leejun Industrial

How Do You 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 Chengdu Leejun Industrial is:

9.7% = CN¥229m ÷ CN¥2.4b (Based on the trailing twelve months to September 2021).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.10 in profit.

What Is The Relationship Between ROE And 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.

A Side By Side comparison of Chengdu Leejun Industrial's Earnings Growth And 9.7% ROE

On the face of it, Chengdu Leejun Industrial's ROE is not much to talk about. However, given that the company's ROE is similar to the average industry ROE of 9.3%, we may spare it some thought. On the other hand, Chengdu Leejun Industrial reported a moderate 18% net income growth over the past five years. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Chengdu Leejun Industrial's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 15% in the same period.

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. If you're wondering about Chengdu Leejun Industrial's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Chengdu Leejun Industrial Using Its Retained Earnings Effectively?

Chengdu Leejun Industrial has a healthy combination of a moderate three-year median payout ratio of 46% (or a retention ratio of 54%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Moreover, Chengdu Leejun Industrial is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Summary

On the whole, we do feel that Chengdu Leejun Industrial has some positive attributes. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 3 risks we have identified for Chengdu Leejun Industrial 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.