Qingmu Digital TechnologyLtd (SZSE:301110) has had a great run on the share market with its stock up by a significant 23% over the last three months. 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. Specifically, we decided to study Qingmu Digital TechnologyLtd's ROE in this article.

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.

View our latest analysis for Qingmu Digital TechnologyLtd

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 Qingmu Digital TechnologyLtd is:

8.1% = CN¥112m ÷ CN¥1.4b (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¥0.08 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

Qingmu Digital TechnologyLtd's Earnings Growth And 8.1% ROE

At first glance, Qingmu Digital TechnologyLtd's ROE doesn't look very promising. However, its ROE is similar to the industry average of 8.1%, so we won't completely dismiss the company. Particularly, the exceptional 20% net income growth seen by Qingmu Digital TechnologyLtd over the past five years is pretty remarkable. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Qingmu Digital TechnologyLtd's growth is quite high when compared to the industry average growth of 8.8% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Qingmu Digital TechnologyLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Qingmu Digital TechnologyLtd Using Its Retained Earnings Effectively?

Qingmu Digital TechnologyLtd's three-year median payout ratio is a pretty moderate 29%, meaning the company retains 71% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Qingmu Digital TechnologyLtd is reinvesting its earnings efficiently.

While Qingmu Digital TechnologyLtd 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.

Summary

In total, it does look like Qingmu Digital TechnologyLtd has some positive aspects to its business. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. 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 Qingmu Digital TechnologyLtd.

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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.