Impro Precision Industries' (HKG:1286) stock is up by a considerable 18% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. In this article, we decided to focus on Impro Precision Industries' ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Impro Precision Industries

How To Calculate Return On Equity?

Return on equity 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 Impro Precision Industries is:

8.8% = HK$386m ÷ HK$4.4b (Based on the trailing twelve months to December 2021).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every HK$1 worth of equity, the company was able to earn HK$0.09 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. 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 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.

Impro Precision Industries' Earnings Growth And 8.8% ROE

When you first look at it, Impro Precision Industries' ROE doesn't look that attractive. However, its ROE is similar to the industry average of 9.3%, so we won't completely dismiss the company. Having said that, Impro Precision Industries' five year net income decline rate was 18%. Remember, the company's ROE is a bit low to begin with. So that's what might be causing earnings growth to shrink.

So, as a next step, we compared Impro Precision Industries' performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 19% in the same period.

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 Impro Precision Industries fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Impro Precision Industries Making Efficient Use Of Its Profits?

Despite having a normal three-year median payout ratio of 31% (where it is retaining 69% of its profits), Impro Precision Industries has seen a decline in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Moreover, Impro Precision Industries has been paying dividends for three years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking.

Conclusion

In total, we're a bit ambivalent about Impro Precision Industries' performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. To know the 2 risks we have identified for Impro Precision Industries visit our risks dashboard for free.

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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.