With its stock down 28% over the past three months, it is easy to disregard Mingyue Optical LensLtd (SZSE:301101). However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Mingyue Optical LensLtd's ROE today.

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 Do You 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 Mingyue Optical LensLtd is:

12% = CN¥186m ÷ CN¥1.6b (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¥0.12 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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.

Mingyue Optical LensLtd's Earnings Growth And 12% ROE

To start with, Mingyue Optical LensLtd's ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 10.0%. Consequently, this likely laid the ground for the impressive net income growth of 28% seen over the past five years by Mingyue Optical LensLtd. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Mingyue Optical LensLtd'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 15%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Mingyue Optical LensLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Mingyue Optical LensLtd Using Its Retained Earnings Effectively?

Mingyue Optical LensLtd's three-year median payout ratio is a pretty moderate 44%, meaning the company retains 56% of its income. By the looks of it, the dividend is well covered and Mingyue Optical LensLtd is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

While Mingyue Optical LensLtd has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 38%. As a result, Mingyue Optical LensLtd's ROE is not expected to change by much either, which we inferred from the analyst estimate of 13% for future ROE.

Summary

In total, we are pretty happy with Mingyue Optical LensLtd'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. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.