Shanghai GenTech (SHSE:688596) has had a great run on the share market with its stock up by a significant 15% over the last three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Shanghai GenTech's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Shanghai GenTech

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Shanghai GenTech is:

14% = CN¥412m ÷ CN¥2.9b (Based on the trailing twelve months to September 2023).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.14 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Shanghai GenTech's Earnings Growth And 14% ROE

At first glance, Shanghai GenTech seems to have a decent ROE. On comparing with the average industry ROE of 5.8% the company's ROE looks pretty remarkable. This probably laid the ground for Shanghai GenTech's significant 36% net income growth seen over the past five years. However, there could also be other causes behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that Shanghai GenTech's growth is quite high when compared to the industry average growth of 29% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Shanghai GenTech is trading on a high P/E or a low P/E, relative to its industry.

Is Shanghai GenTech Efficiently Re-investing Its Profits?

While the company did pay out a portion of its dividend in the past, it currently doesn't pay a dividend. This is likely what's driving the high earnings growth number discussed above.

Conclusion

Overall, we are quite pleased with Shanghai GenTech's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.