Most readers would already be aware that Dongguan Tarry ElectronicsLtd's (SZSE:300976) stock increased significantly by 17% over the past week. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. In this article, we decided to focus on Dongguan Tarry ElectronicsLtd's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

How Is ROE Calculated?

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 Dongguan Tarry ElectronicsLtd is:

3.0% = CN¥96m ÷ CN¥3.2b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.03 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

Dongguan Tarry ElectronicsLtd's Earnings Growth And 3.0% ROE

It is hard to argue that Dongguan Tarry ElectronicsLtd's ROE is much good in and of itself. Not just that, even compared to the industry average of 6.3%, the company's ROE is entirely unremarkable. Therefore, it might not be wrong to say that the five year net income decline of 19% seen by Dongguan Tarry ElectronicsLtd was possibly a result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared Dongguan Tarry ElectronicsLtd's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 8.8% in the same period. This is quite worrisome.

Earnings growth is an important metric to consider when valuing a stock. 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. Is Dongguan Tarry ElectronicsLtd fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Dongguan Tarry ElectronicsLtd Efficiently Re-investing Its Profits?

Despite having a normal three-year median payout ratio of 40% (where it is retaining 60% of its profits), Dongguan Tarry ElectronicsLtd 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.

Additionally, Dongguan Tarry ElectronicsLtd has paid dividends over a period of three years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Conclusion

On the whole, we feel that the performance shown by Dongguan Tarry ElectronicsLtd can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. 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 3 risks we have identified for Dongguan Tarry ElectronicsLtd 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.