With its stock down 13% over the past month, it is easy to disregard SG Micro (SZSE:300661). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on SG Micro's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for SG Micro

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for SG Micro is:

32% = CN¥873m ÷ CN¥2.7b (Based on the trailing twelve months to March 2022).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.32 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

SG Micro's Earnings Growth And 32% ROE

To begin with, SG Micro has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 9.5% the company's ROE is quite impressive. As a result, SG Micro's exceptional 49% net income growth seen over the past five years, doesn't come as a surprise.

We then compared SG Micro's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 30% in the same period.

Earnings growth is a huge factor in stock valuation. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if SG Micro is trading on a high P/E or a low P/E, relative to its industry.

Is SG Micro Efficiently Re-investing Its Profits?

SG Micro's ' three-year median payout ratio is on the lower side at 23% implying that it is retaining a higher percentage (77%) of its profits. So it looks like SG Micro is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Besides, SG Micro has been paying dividends over a period of four years. This shows that the company is committed to sharing profits with its shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 15% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.

Conclusion

On the whole, we feel that SG Micro's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.