It is hard to get excited after looking at Shandong Shanda OumasoftLTD's (SZSE:301185) recent performance, when its stock has declined 27% over the past three months. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Shandong Shanda OumasoftLTD's ROE in this article.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

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 Shandong Shanda OumasoftLTD is:

6.2% = CN¥62m ÷ CN¥1.0b (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¥0.06 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 Shandong Shanda OumasoftLTD's Earnings Growth And 6.2% ROE

When you first look at it, Shandong Shanda OumasoftLTD's ROE doesn't look that attractive. However, the fact that the its ROE is quite higher to the industry average of 4.4% doesn't go unnoticed by us. Still, Shandong Shanda OumasoftLTD's net income growth of 2.9% over the past five years was mediocre at best. Remember, the company's ROE is quite low to begin with, just that it is higher than the industry average. So that could be one of the factors that are causing earnings growth to stay low.

We then compared Shandong Shanda OumasoftLTD's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 4.6% in the same 5-year period, which is a bit concerning.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Shandong Shanda OumasoftLTD's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shandong Shanda OumasoftLTD Using Its Retained Earnings Effectively?

Despite having a moderate three-year median payout ratio of 31% (implying that the company retains the remaining 69% of its income), Shandong Shanda OumasoftLTD's earnings growth was quite low. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Only recently, Shandong Shanda OumasoftLTD started paying a dividend. This means that the management might have concluded that its shareholders prefer dividends over earnings growth.

Conclusion

On the whole, we do feel that Shandong Shanda OumasoftLTD has some positive attributes. However, while the company does have a decent ROE and a high profit retention, its earnings growth number is quite disappointing. This suggests that there might be some external threat to the business, that's hampering growth. 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. To know the 1 risk we have identified for Shandong Shanda OumasoftLTD visit our risks dashboard for free.

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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.