Sichuan Teway Food GroupLtd (SHSE:603317) has had a great run on the share market with its stock up by a significant 12% over the last month. 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 Sichuan Teway Food GroupLtd's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How To Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for Sichuan Teway Food GroupLtd is:

11% = CN¥466m ÷ CN¥4.4b (Based on the trailing twelve months to December 2023).

The 'return' refers to a company's earnings over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.11.

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. 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 Sichuan Teway Food GroupLtd's Earnings Growth And 11% ROE

When you first look at it, Sichuan Teway Food GroupLtd's ROE doesn't look that attractive. However, the fact that the company's ROE is higher than the average industry ROE of 8.4%, is definitely interesting. This probably goes some way in explaining Sichuan Teway Food GroupLtd's moderate 5.0% growth over the past five years amongst other factors. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. So there might well be other reasons for the earnings to grow. For example, it is possible that the broader industry is going through a high growth phase, or that the company has a low payout ratio.

Next, on comparing with the industry net income growth, we found that Sichuan Teway Food GroupLtd's reported growth was lower than the industry growth of 7.3% over the last few years, which is not something we like to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is 603317 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Sichuan Teway Food GroupLtd Using Its Retained Earnings Effectively?

Sichuan Teway Food GroupLtd has a significant three-year median payout ratio of 57%, meaning that it is left with only 43% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Moreover, Sichuan Teway Food GroupLtd is determined to keep sharing its profits with shareholders which we infer from its long history of five years of paying a dividend. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 21% over the next three years. The fact that the company's ROE is expected to rise to 14% over the same period is explained by the drop in the payout ratio.

Conclusion

In total, it does look like Sichuan Teway Food GroupLtd has some positive aspects to its business. Its earnings have grown respectably as we saw earlier, which was likely achieved by the company reinvesting its earnings at a decent rate of return. Still, its earnings retention is quite low, so we wonder if the company's growth could be higher, were it to pay out less dividends and retain more of its profits? That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.