Most readers would already be aware that Yarward Electronics (Shandong)'s (SZSE:301337) stock increased significantly by 45% over the past week. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Yarward Electronics (Shandong)'s ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Is ROE Calculated?

ROE can be calculated by using the formula:

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

So, based on the above formula, the ROE for Yarward Electronics (Shandong) is:

5.0% = CN¥57m ÷ CN¥1.1b (Based on the trailing twelve months to September 2023).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.05 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

A Side By Side comparison of Yarward Electronics (Shandong)'s Earnings Growth And 5.0% ROE

When you first look at it, Yarward Electronics (Shandong)'s ROE doesn't look that attractive. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 13%. In spite of this, Yarward Electronics (Shandong) was able to grow its net income considerably, at a rate of 36% in the last five years. Therefore, there could be other reasons behind this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Yarward Electronics (Shandong)'s net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 18%.

Earnings growth is a huge factor in stock valuation. 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 Yarward Electronics (Shandong)'s's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Yarward Electronics (Shandong) Efficiently Re-investing Its Profits?

Yarward Electronics (Shandong)'s ' three-year median payout ratio is on the lower side at 23% implying that it is retaining a higher percentage (77%) of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

Along with seeing a growth in earnings, Yarward Electronics (Shandong) only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders.

Conclusion

In total, it does look like Yarward Electronics (Shandong) has some positive aspects to its business. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable 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. You can see the 4 risks we have identified for Yarward Electronics (Shandong) 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.