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Churchill China (LON:CHH) has had a rough three months with its share price down 3.0%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Churchill China's ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
View our latest analysis for Churchill China
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 Churchill China is:
14% = UK£8.2m ÷ UK£58m (Based on the trailing twelve months to June 2023).
The 'return' is the yearly profit. That means that for every £1 worth of shareholders' equity, the company generated £0.14 in profit.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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.
Churchill China's Earnings Growth And 14% ROE
At first glance, Churchill China seems to have a decent ROE. On comparing with the average industry ROE of 10% the company's ROE looks pretty remarkable. As you might expect, the 3.6% net income decline reported by Churchill China is a bit of a surprise. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. These include low earnings retention or poor allocation of capital.
From the 3.6% decline reported by the industry in the same period, we infer that Churchill China and its industry are both shrinking at a similar rate.
Earnings growth is an important metric to consider when valuing a stock. 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. If you're wondering about Churchill China's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.