Zhejiang Lante Optics' (SHSE:688127) stock is up by a considerable 36% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Zhejiang Lante Optics' ROE in this article.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Zhejiang Lante Optics

How Do You Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Zhejiang Lante Optics is:

8.3% = CN¥124m ÷ CN¥1.5b (Based on the trailing twelve months to March 2022).

The 'return' is the income the business earned over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.08 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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.

A Side By Side comparison of Zhejiang Lante Optics' Earnings Growth And 8.3% ROE

On the face of it, Zhejiang Lante Optics' ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 8.9%. On the other hand, Zhejiang Lante Optics reported a moderate 13% net income growth over the past five years. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Zhejiang Lante Optics' 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 16% in the same period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for 688127? You can find out in our latest intrinsic value infographic research report.

Is Zhejiang Lante Optics Efficiently Re-investing Its Profits?

Zhejiang Lante Optics has a three-year median payout ratio of 46%, which implies that it retains the remaining 54% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Along with seeing a growth in earnings, Zhejiang Lante Optics only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 30% over the next three years. The fact that the company's ROE is expected to rise to 18% over the same period is explained by the drop in the payout ratio.

Conclusion

On the whole, we do feel that Zhejiang Lante Optics has some positive attributes. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.