Most readers would already know that Pony Testing's (SZSE:300887) stock increased by 9.2% 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. In this article, we decided to focus on Pony Testing'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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Pony Testing

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 Pony Testing is:

8.2% = CN¥268m ÷ CN¥3.3b (Based on the trailing twelve months to March 2022).

The 'return' is the yearly profit. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made 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. 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 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.

Pony Testing's Earnings Growth And 8.2% ROE

At first glance, Pony Testing's ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.6%. Looking at Pony Testing's exceptional 21% five-year net income growth in particular, we are definitely impressed. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Pony Testing'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 8.9%.

Earnings growth is an important metric to consider when valuing a stock. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Pony Testing's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Pony Testing Using Its Retained Earnings Effectively?

Pony Testing's three-year median payout ratio to shareholders is 20%, which is quite low. This implies that the company is retaining 80% of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

While Pony Testing has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 26% over the next three years. Regardless, the future ROE for Pony Testing is speculated to rise to 14% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.

Conclusion

In total, it does look like Pony Testing has some positive aspects to its business. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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.