It is hard to get excited after looking at L&K Engineering (Suzhou)Ltd's (SHSE:603929) recent performance, when its stock has declined 26% 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. Particularly, we will be paying attention to L&K Engineering (Suzhou)Ltd'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.

How To 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 L&K Engineering (Suzhou)Ltd is:

23% = CN¥316m ÷ CN¥1.4b (Based on the trailing twelve months to September 2023).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.23 in profit.

What Is The Relationship Between ROE And 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 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.

L&K Engineering (Suzhou)Ltd's Earnings Growth And 23% ROE

To begin with, L&K Engineering (Suzhou)Ltd has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 7.6% which is quite remarkable. This likely paved the way for the modest 7.9% net income growth seen by L&K Engineering (Suzhou)Ltd over the past five years.

As a next step, we compared L&K Engineering (Suzhou)Ltd's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 8.4% in the same period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 L&K Engineering (Suzhou)Ltd is trading on a high P/E or a low P/E, relative to its industry.

Is L&K Engineering (Suzhou)Ltd Making Efficient Use Of Its Profits?

With a three-year median payout ratio of 28% (implying that the company retains 72% of its profits), it seems that L&K Engineering (Suzhou)Ltd is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Besides, L&K Engineering (Suzhou)Ltd has been paying dividends over a period of seven years. This shows that the company is committed to sharing profits with its shareholders.

Summary

In total, we are pretty happy with L&K Engineering (Suzhou)Ltd'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. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. You can see the 1 risk we have identified for L&K Engineering (Suzhou)Ltd by visiting our risks dashboard for free on our platform here.

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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.