SG Micro (SZSE:300661) has had a great run on the share market with its stock up by a significant 18% over the last month. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Particularly, we will be paying attention to SG Micro's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for SG Micro

How Do You Calculate Return On Equity?

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 SG Micro is:

6.9% = CN¥253m ÷ CN¥3.7b (Based on the trailing twelve months to September 2023).

The 'return' is the profit over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.07 in profit.

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. 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.

A Side By Side comparison of SG Micro's Earnings Growth And 6.9% ROE

On the face of it, SG Micro's ROE is not much to talk about. However, its ROE is similar to the industry average of 5.8%, so we won't completely dismiss the company. Looking at SG Micro's exceptional 35% five-year net income growth in particular, we are definitely impressed. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared SG Micro'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 29% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. 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 SG Micro is trading on a high P/E or a low P/E, relative to its industry.

Is SG Micro Making Efficient Use Of Its Profits?

SG Micro's three-year median payout ratio to shareholders is 17%, which is quite low. This implies that the company is retaining 83% of its profits. So it looks like SG Micro is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Besides, SG Micro has been paying dividends over a period of five years. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 24% over the next three years. However, SG Micro's future ROE is expected to rise to 19% despite the expected increase in the company's payout ratio. We infer that there could be other factors that could be driving the anticipated growth in the company's ROE.

Summary

Overall, we feel that SG Micro certainly does have some positive factors to consider. 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. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.