With its stock down 18% over the past three months, it is easy to disregard Shanghai Labway Clinical Laboratory (SZSE:301060). However, stock prices are usually driven by a company's financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Shanghai Labway Clinical Laboratory's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Shanghai Labway Clinical Laboratory

How To 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 Shanghai Labway Clinical Laboratory is:

9.1% = CN¥195m ÷ CN¥2.1b (Based on the trailing twelve months to June 2023).

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¥0.09.

Why Is ROE Important For 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.

Shanghai Labway Clinical Laboratory's Earnings Growth And 9.1% ROE

At first glance, Shanghai Labway Clinical Laboratory's ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 9.1%. Particularly, the exceptional 37% net income growth seen by Shanghai Labway Clinical Laboratory over the past five years is pretty remarkable. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Shanghai Labway Clinical Laboratory'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 9.3%.

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). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Shanghai Labway Clinical Laboratory's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shanghai Labway Clinical Laboratory Using Its Retained Earnings Effectively?

Shanghai Labway Clinical Laboratory has a three-year median payout ratio of 26% (where it is retaining 74% of its income) which is not too low or not too high. By the looks of it, the dividend is well covered and Shanghai Labway Clinical Laboratory is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Along with seeing a growth in earnings, Shanghai Labway Clinical Laboratory only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders.

Summary

On the whole, we do feel that Shanghai Labway Clinical Laboratory has some positive attributes. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. 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. You can see the 3 risks we have identified for Shanghai Labway Clinical Laboratory 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.