It is hard to get excited after looking at Sichuan Joyou Digital TechnologiesLtd's (SZSE:301172) recent performance, when its stock has declined 14% over the past three months. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Sichuan Joyou Digital TechnologiesLtd'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

How Do You Calculate Return On Equity?

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 Sichuan Joyou Digital TechnologiesLtd is:

5.2% = CN¥74m ÷ CN¥1.4b (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.05 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Sichuan Joyou Digital TechnologiesLtd's Earnings Growth And 5.2% ROE

On the face of it, Sichuan Joyou Digital TechnologiesLtd's ROE is not much to talk about. However, its ROE is similar to the industry average of 5.2%, so we won't completely dismiss the company. Looking at Sichuan Joyou Digital TechnologiesLtd's exceptional 39% five-year net income growth in particular, we are definitely impressed. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Sichuan Joyou Digital TechnologiesLtd's growth is quite high when compared to the industry average growth of 6.6% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. 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 Sichuan Joyou Digital TechnologiesLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Sichuan Joyou Digital TechnologiesLtd Making Efficient Use Of Its Profits?

Sichuan Joyou Digital TechnologiesLtd has a really low three-year median payout ratio of 18%, meaning that it has the remaining 82% left over to reinvest into its business. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Summary

Overall, we feel that Sichuan Joyou Digital TechnologiesLtd certainly does have some positive factors to consider. 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. To know the 3 risks we have identified for Sichuan Joyou Digital TechnologiesLtd visit our risks dashboard for free.

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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.