Most readers would already be aware that Estun Automation's (SZSE:002747) stock increased significantly by 47% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study Estun Automation's ROE in this article.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Estun Automation

How Do You Calculate Return On Equity?

ROE 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 Estun Automation is:

6.2% = CN¥182m ÷ CN¥2.9b (Based on the trailing twelve months to March 2022).

The 'return' is the yearly profit. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.06.

Why Is ROE Important For Earnings Growth?

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

A Side By Side comparison of Estun Automation's Earnings Growth And 6.2% ROE

When you first look at it, Estun Automation's ROE doesn't look that attractive. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 8.2%. Although, we can see that Estun Automation saw a modest net income growth of 8.9% over the past five years. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Estun Automation's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 14% 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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Estun Automation is trading on a high P/E or a low P/E, relative to its industry.

Is Estun Automation Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 54% (or a retention ratio of 46%) for Estun Automation suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Additionally, Estun Automation has paid dividends over a period of seven years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 16% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 16%, over the same period.

Conclusion

On the whole, we feel that the performance shown by Estun Automation can be open to many interpretations. While the company has posted a decent earnings growth, We do feel that the earnings growth number could have been even higher, had the company been reinvesting more of its earnings at a higher rate of return. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.