Most readers would already be aware that Shandong Swan CottonIndustrial Machinery StockLtd's (SHSE:603029) stock increased significantly by 43% over the past month. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to Shandong Swan CottonIndustrial Machinery StockLtd's 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Shandong Swan CottonIndustrial Machinery StockLtd

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 Shandong Swan CottonIndustrial Machinery StockLtd is:

5.7% = CN¥43m ÷ CN¥755m (Based on the trailing twelve months to September 2022).

The 'return' is the yearly profit. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.06 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. 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.

A Side By Side comparison of Shandong Swan CottonIndustrial Machinery StockLtd's Earnings Growth And 5.7% ROE

When you first look at it, Shandong Swan CottonIndustrial Machinery StockLtd's ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 7.7% either. In spite of this, Shandong Swan CottonIndustrial Machinery StockLtd was able to grow its net income considerably, at a rate of 33% in the last five years. So, there might be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared Shandong Swan CottonIndustrial Machinery StockLtd'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 12% in the same period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Shandong Swan CottonIndustrial Machinery StockLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Shandong Swan CottonIndustrial Machinery StockLtd Making Efficient Use Of Its Profits?

Shandong Swan CottonIndustrial Machinery StockLtd has a three-year median payout ratio of 40% (where it is retaining 60% of its income) which is not too low or not too high. By the looks of it, the dividend is well covered and Shandong Swan CottonIndustrial Machinery StockLtd is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Besides, Shandong Swan CottonIndustrial Machinery StockLtd has been paying dividends over a period of five years. This shows that the company is committed to sharing profits with its shareholders.

Conclusion

On the whole, we do feel that Shandong Swan CottonIndustrial Machinery StockLtd has some positive attributes. 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. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard would have the 2 risks we have identified for Shandong Swan CottonIndustrial Machinery StockLtd.

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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.