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With its stock down 33% over the past three months, it is easy to disregard Churchill China (LON:CHH). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Churchill China's ROE today.
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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
See our latest analysis for Churchill China
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Churchill China is:
13% = UK£7.8m ÷ UK£61m (Based on the trailing twelve months to June 2024).
The 'return' is the income the business earned over the last year. That means that for every £1 worth of shareholders' equity, the company generated £0.13 in profit.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
Churchill China's Earnings Growth And 13% ROE
To begin with, Churchill China seems to have a respectable ROE. On comparing with the average industry ROE of 6.0% the company's ROE looks pretty remarkable. This certainly adds some context to Churchill China's decent 8.5% net income growth seen over the past five years.
Next, on comparing with the industry net income growth, we found that the growth figure reported by Churchill China compares quite favourably to the industry average, which shows a decline of 0.4% over the last few years.
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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Churchill China is trading on a high P/E or a low P/E, relative to its industry.