Gansu Guofang Industry & Trade (Group) (SHSE:601086) has had a rough three months with its share price down 24%. However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Gansu Guofang Industry & Trade (Group)'s ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. 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?

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 Gansu Guofang Industry & Trade (Group) is:

12% = CN¥198m ÷ CN¥1.6b (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.12 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.

Gansu Guofang Industry & Trade (Group)'s Earnings Growth And 12% ROE

To begin with, Gansu Guofang Industry & Trade (Group) seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 5.3%. Yet, Gansu Guofang Industry & Trade (Group) has posted measly growth of 4.0% over the past five years. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

When you consider the fact that the industry earnings have shrunk at a rate of 6.7% in the same 5-year period, the company's net income growth is pretty remarkable.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Gansu Guofang Industry & Trade (Group)'s's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Gansu Guofang Industry & Trade (Group) Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 90% (or a retention ratio of 10%), most of Gansu Guofang Industry & Trade (Group)'s profits are being paid to shareholders. This definitely contributes to the low earnings growth seen by the company.

Moreover, Gansu Guofang Industry & Trade (Group) has been paying dividends for six years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

On the whole, we feel that Gansu Guofang Industry & Trade (Group)'s performance has been quite good. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. Our risks dashboard would have the 2 risks we have identified for Gansu Guofang Industry & Trade (Group).

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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.