Suzhou TFC Optical Communication (SZSE:300394) has had a great run on the share market with its stock up by a significant 88% over the last three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Suzhou TFC Optical Communication'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

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 Suzhou TFC Optical Communication is:

25% = CN¥730m ÷ CN¥3.0b (Based on the trailing twelve months to December 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¥0.25 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company's earnings growth potential. 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.

Suzhou TFC Optical Communication's Earnings Growth And 25% ROE

Firstly, we acknowledge that Suzhou TFC Optical Communication has a significantly high ROE. Secondly, even when compared to the industry average of 6.4% the company's ROE is quite impressive. So, the substantial 29% net income growth seen by Suzhou TFC Optical Communication over the past five years isn't overly surprising.

As a next step, we compared Suzhou TFC Optical Communication'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 12%.

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). 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 Suzhou TFC Optical Communication is trading on a high P/E or a low P/E, relative to its industry.

Is Suzhou TFC Optical Communication Efficiently Re-investing Its Profits?

Suzhou TFC Optical Communication has a three-year median payout ratio of 44% (where it is retaining 56% of its income) which is not too low or not too high. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Suzhou TFC Optical Communication is reinvesting its earnings efficiently.

Additionally, Suzhou TFC Optical Communication has paid dividends over a period of nine years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 49% of its profits over the next three years. Regardless, the future ROE for Suzhou TFC Optical Communication is predicted to rise to 30% despite there being not much change expected in its payout ratio.

Conclusion

In total, we are pretty happy with Suzhou TFC Optical Communication's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.