Shanghai Golden Bridge InfoTechLtd's (SHSE:603918) stock is up by a considerable 35% over the past month. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study Shanghai Golden Bridge InfoTechLtd'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

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 Shanghai Golden Bridge InfoTechLtd is:

2.3% = CN¥25m ÷ CN¥1.1b (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¥0.02 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. 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 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.

Shanghai Golden Bridge InfoTechLtd's Earnings Growth And 2.3% ROE

As you can see, Shanghai Golden Bridge InfoTechLtd's ROE looks pretty weak. Even when compared to the industry average of 4.2%, the ROE figure is pretty disappointing. For this reason, Shanghai Golden Bridge InfoTechLtd's five year net income decline of 5.3% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared Shanghai Golden Bridge InfoTechLtd's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 4.8% in the same period. This is quite worrisome.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. 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 Shanghai Golden Bridge InfoTechLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Shanghai Golden Bridge InfoTechLtd Efficiently Re-investing Its Profits?

Looking at its three-year median payout ratio of 40% (or a retention ratio of 60%) which is pretty normal, Shanghai Golden Bridge InfoTechLtd's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, Shanghai Golden Bridge InfoTechLtd has paid dividends over a period of eight years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Summary

In total, we're a bit ambivalent about Shanghai Golden Bridge InfoTechLtd's performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.