It is hard to get excited after looking at Winstech Precision Holding's (SZSE:001319) recent performance, when its stock has declined 38% over the past three months. However, stock prices are usually driven by a company's financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Winstech Precision Holding's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. 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 Winstech Precision Holding is:

7.1% = CN¥86m ÷ CN¥1.2b (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.07 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

A Side By Side comparison of Winstech Precision Holding's Earnings Growth And 7.1% ROE

When you first look at it, Winstech Precision Holding's ROE doesn't look that attractive. However, its ROE is similar to the industry average of 7.3%, so we won't completely dismiss the company. On the other hand, Winstech Precision Holding reported a fairly low 3.6% net income growth over the past five years. Bear in mind, the company's ROE is not very high . So this could also be one of the reasons behind the company's low growth in earnings.

Next, on comparing Winstech Precision Holding's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 3.8% over the last few years.

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. 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 Winstech Precision Holding is trading on a high P/E or a low P/E, relative to its industry.

Is Winstech Precision Holding Using Its Retained Earnings Effectively?

Despite having a moderate three-year median payout ratio of 42% (implying that the company retains the remaining 58% of its income), Winstech Precision Holding's earnings growth was quite low. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

In addition, Winstech Precision Holding only recently started paying a dividend so the management must have decided the shareholders prefer dividends over earnings growth.

Summary

On the whole, we do feel that Winstech Precision Holding has some positive attributes. That is, a decent growth in earnings backed by a high rate of reinvestment. However, we do feel that that earnings growth could have been higher if the business were to improve on the low ROE rate. Especially given how the company is reinvesting a huge chunk of its profits. 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 1 risk we have identified for Winstech Precision Holding by visiting our risks dashboard for free on our platform here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.