Shanghai Lianming Machinery's (SHSE:603006) stock is up by a considerable 50% over the past 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. Specifically, we decided to study Shanghai Lianming Machinery's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How To Calculate Return On Equity?

Return on equity 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 Shanghai Lianming Machinery is:

8.8% = CN¥150m ÷ CN¥1.7b (Based on the trailing twelve months to September 2023).

The 'return' is the income the business earned over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.09.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Shanghai Lianming Machinery's Earnings Growth And 8.8% ROE

At first glance, Shanghai Lianming Machinery's ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.5%. Even so, Shanghai Lianming Machinery has shown a fairly decent growth in its net income which grew at a rate of 9.6%. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. Such as - high earnings retention or an efficient management in place.

We then compared Shanghai Lianming Machinery's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 3.8% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Shanghai Lianming Machinery's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shanghai Lianming Machinery Efficiently Re-investing Its Profits?

Shanghai Lianming Machinery has a significant three-year median payout ratio of 63%, meaning that it is left with only 37% 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.

Additionally, Shanghai Lianming Machinery has paid dividends over a period of nine years which means that the company is pretty serious about sharing its profits with shareholders.

Summary

Overall, we feel that Shanghai Lianming Machinery certainly does have some positive factors to consider. That is, quite an impressive growth in earnings. However, the low profit retention means that the company's earnings growth could have been higher, had it been reinvesting a higher portion of its profits. So far, we've only made a quick discussion around the company's earnings growth. To gain further insights into Shanghai Lianming Machinery's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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.