With its stock down 29% over the past three months, it is easy to disregard West Shanghai Automotive ServiceLtd (SHSE:605151). 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 West Shanghai Automotive ServiceLtd'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 Is ROE Calculated?

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 West Shanghai Automotive ServiceLtd is:

9.5% = CN¥131m ÷ CN¥1.4b (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.

What Has ROE Got To Do With 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 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.

West Shanghai Automotive ServiceLtd's Earnings Growth And 9.5% ROE

At first glance, West Shanghai Automotive ServiceLtd's ROE doesn't look very promising. However, the fact that the its ROE is quite higher to the industry average of 7.3% doesn't go unnoticed by us. However, West Shanghai Automotive ServiceLtd's five year net income growth was quite low averaging at only 3.8%. 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 performed a comparison between West Shanghai Automotive ServiceLtd's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 3.8% in the same 5-year period.

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about West Shanghai Automotive ServiceLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is West Shanghai Automotive ServiceLtd Efficiently Re-investing Its Profits?

Despite having a moderate three-year median payout ratio of 35% (implying that the company retains the remaining 65% of its income), West Shanghai Automotive ServiceLtd'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.

In addition, West Shanghai Automotive ServiceLtd has been paying dividends over a period of three 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

In total, it does look like West Shanghai Automotive ServiceLtd has some positive aspects to its business. Specifically, we like that the company is reinvesting a huge chunk of its profits at a respectable rate of return. This of course has caused the company to see a good amount of growth in its earnings. 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 3 risks we have identified for West Shanghai Automotive ServiceLtd 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.