First Tractor's (HKG:38) stock is up by a considerable 11% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on First Tractor's ROE.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

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 First Tractor is:

14% = CN¥1.1b ÷ CN¥7.8b (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 HK$1 worth of shareholders' equity, the company generated HK$0.14 in profit.

What Has ROE Got To Do With 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 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.

A Side By Side comparison of First Tractor's Earnings Growth And 14% ROE

To start with, First Tractor's ROE looks acceptable. Especially when compared to the industry average of 11% the company's ROE looks pretty impressive. This probably laid the ground for First Tractor's significant 56% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared First Tractor'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 9.1%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about First Tractor's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is First Tractor Efficiently Re-investing Its Profits?

First Tractor's three-year median payout ratio is a pretty moderate 28%, meaning the company retains 72% of its income. By the looks of it, the dividend is well covered and First Tractor is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Besides, First Tractor has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.

Conclusion

In total, we are pretty happy with First Tractor's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.