It is hard to get excited after looking at Sanxiang Advanced Materials' (SHSE:603663) recent performance, when its stock has declined 18% over the past month. 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. Particularly, we will be paying attention to Sanxiang Advanced Materials' ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Sanxiang Advanced Materials

How Is ROE Calculated?

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 Sanxiang Advanced Materials is:

12% = CN¥141m ÷ CN¥1.2b (Based on the trailing twelve months to June 2022).

The 'return' refers to a company's earnings over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.12.

Why Is ROE Important For Earnings Growth?

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

Sanxiang Advanced Materials' Earnings Growth And 12% ROE

At first glance, Sanxiang Advanced Materials seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 11%. This certainly adds some context to Sanxiang Advanced Materials' moderate 13% net income growth seen over the past five years.

As a next step, we compared Sanxiang Advanced Materials' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 19% 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. Is Sanxiang Advanced Materials fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Sanxiang Advanced Materials Using Its Retained Earnings Effectively?

With a three-year median payout ratio of 25% (implying that the company retains 75% of its profits), it seems that Sanxiang Advanced Materials is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Moreover, Sanxiang Advanced Materials is determined to keep sharing its profits with shareholders which we infer from its long history of five years of paying a dividend.

Summary

In total, we are pretty happy with Sanxiang Advanced Materials' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. You can see the 3 risks we have identified for Sanxiang Advanced Materials by visiting our risks dashboard for free on our platform here.

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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.