Shanghai Wanye EnterprisesLtd (SHSE:600641) has had a great run on the share market with its stock up by a significant 7.7% over the last month. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. Specifically, we decided to study Shanghai Wanye EnterprisesLtd's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Shanghai Wanye EnterprisesLtd

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 Wanye EnterprisesLtd is:

5.3% = CN¥451m ÷ CN¥8.5b (Based on the trailing twelve months to September 2023).

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¥0.05 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. 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. 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 Wanye EnterprisesLtd's Earnings Growth And 5.3% ROE

At first glance, Shanghai Wanye EnterprisesLtd's ROE doesn't look very promising. However, its ROE is similar to the industry average of 5.5%, so we won't completely dismiss the company. Having said that, Shanghai Wanye EnterprisesLtd's five year net income decline rate was 19%. Remember, the company's ROE is a bit low to begin with. So that's what might be causing earnings growth to shrink.

Next, when we compared with the industry, which has shrunk its earnings at a rate of 4.6% in the same 5-year period, we still found Shanghai Wanye EnterprisesLtd's performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.

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. 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 Wanye EnterprisesLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Shanghai Wanye EnterprisesLtd Making Efficient Use Of Its Profits?

In spite of a normal three-year median payout ratio of 28% (that is, a retention ratio of 72%), the fact that Shanghai Wanye EnterprisesLtd's earnings have shrunk is quite puzzling. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

In addition, Shanghai Wanye EnterprisesLtd has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Summary

On the whole, we feel that the performance shown by Shanghai Wanye EnterprisesLtd can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.