It is hard to get excited after looking at Jiangsu Guomao Reducer's (SHSE:603915) recent performance, when its stock has declined 28% over the past three months. However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Jiangsu Guomao Reducer's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Jiangsu Guomao Reducer is:

11% = CN¥387m ÷ CN¥3.5b (Based on the trailing twelve months to September 2023).

The 'return' is the profit over the last twelve months. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.11.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Jiangsu Guomao Reducer's Earnings Growth And 11% ROE

To start with, Jiangsu Guomao Reducer's ROE looks acceptable. Especially when compared to the industry average of 7.6% the company's ROE looks pretty impressive. This certainly adds some context to Jiangsu Guomao Reducer's decent 14% net income growth seen over the past five years.

We then performed a comparison between Jiangsu Guomao Reducer's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 12% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. 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. Has the market priced in the future outlook for 603915? You can find out in our latest intrinsic value infographic research report.

Is Jiangsu Guomao Reducer Using Its Retained Earnings Effectively?

Jiangsu Guomao Reducer has a three-year median payout ratio of 31%, which implies that it retains the remaining 69% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Additionally, Jiangsu Guomao Reducer has paid dividends over a period of four years which means that the company is pretty serious about sharing its profits with shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 30%. Regardless, the future ROE for Jiangsu Guomao Reducer is predicted to rise to 14% despite there being not much change expected in its payout ratio.

Conclusion

In total, we are pretty happy with Jiangsu Guomao Reducer's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.