Shan Dong Lu Bei ChemicalLtd (SHSE:600727) has had a rough three months with its share price down 19%. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. In this article, we decided to focus on Shan Dong Lu Bei ChemicalLtd's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Is ROE Calculated?

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 Shan Dong Lu Bei ChemicalLtd is:

4.7% = CN¥157m ÷ CN¥3.3b (Based on the trailing twelve months to December 2023).

The 'return' refers to a company's earnings over the last year. 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.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Shan Dong Lu Bei ChemicalLtd's Earnings Growth And 4.7% ROE

It is hard to argue that Shan Dong Lu Bei ChemicalLtd's ROE is much good in and of itself. Not just that, even compared to the industry average of 7.1%, the company's ROE is entirely unremarkable. Therefore, it might not be wrong to say that the five year net income decline of 17% seen by Shan Dong Lu Bei ChemicalLtd was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared Shan Dong Lu Bei ChemicalLtd's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 11% in the same period. This is quite worrisome.

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. If you're wondering about Shan Dong Lu Bei ChemicalLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shan Dong Lu Bei ChemicalLtd Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 38% (that is, a retention ratio of 62%), the fact that Shan Dong Lu Bei ChemicalLtd's earnings have shrunk is quite puzzling. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, Shan Dong Lu Bei ChemicalLtd has paid dividends over a period of three years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Summary

Overall, we have mixed feelings about Shan Dong Lu Bei ChemicalLtd. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. To know the 2 risks we have identified for Shan Dong Lu Bei ChemicalLtd 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.