Is Zhejiang Dragon Technology Co., Ltd.'s (SHSE:603004) Recent Stock Performance Tethered To Its Strong Fundamentals?

Most readers would already be aware that Zhejiang Dragon Technology's (SHSE:603004) stock increased significantly by 15% over the past month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Zhejiang Dragon Technology'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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Zhejiang Dragon Technology

How To 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 Zhejiang Dragon Technology is:

8.4% = CN¥162m ÷ CN¥1.9b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.08 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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 Zhejiang Dragon Technology's Earnings Growth And 8.4% ROE

On the face of it, Zhejiang Dragon Technology's ROE is not much to talk about. Although a closer study shows that the company's ROE is higher than the industry average of 6.3% which we definitely can't overlook. This certainly adds some context to Zhejiang Dragon Technology's moderate 15% net income growth seen over the past five years. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. Hence there might be some other aspects that are causing earnings to grow. For example, it is possible that the broader industry is going through a high growth phase, or that the company has a low payout ratio.

As a next step, we compared Zhejiang Dragon Technology's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 4.9%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is Zhejiang Dragon Technology fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Zhejiang Dragon Technology Making Efficient Use Of Its Profits?

With a three-year median payout ratio of 27% (implying that the company retains 73% of its profits), it seems that Zhejiang Dragon Technology is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

While Zhejiang Dragon Technology has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend.

Summary

Overall, we are quite pleased with Zhejiang Dragon Technology's performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. You can see the 2 risks we have identified for Zhejiang Dragon Technology 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.