With its stock down 14% over the past three months, it is easy to disregard Shanghai Chlor-Alkali Chemical (SHSE:600618). However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Shanghai Chlor-Alkali Chemical'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.

See our latest analysis for Shanghai Chlor-Alkali Chemical

How Do You 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 Shanghai Chlor-Alkali Chemical is:

12% = CN¥1.1b ÷ CN¥8.5b (Based on the trailing twelve months to March 2023).

The 'return' is the income the business earned 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¥0.12 in profit.

Why Is ROE Important For Earnings Growth?

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

Shanghai Chlor-Alkali Chemical's Earnings Growth And 12% ROE

At first glance, Shanghai Chlor-Alkali Chemical seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 8.3%. Probably as a result of this, Shanghai Chlor-Alkali Chemical was able to see a decent growth of 11% over the last five years.

As a next step, we compared Shanghai Chlor-Alkali Chemical's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 16% in the same period.

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). 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 Shanghai Chlor-Alkali Chemical is trading on a high P/E or a low P/E, relative to its industry.

Is Shanghai Chlor-Alkali Chemical Making Efficient Use Of Its Profits?

Shanghai Chlor-Alkali Chemical's three-year median payout ratio to shareholders is 23% (implying that it retains 77% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Moreover, Shanghai Chlor-Alkali Chemical is determined to keep sharing its profits with shareholders which we infer from its long history of nine years of paying a dividend.

Conclusion

On the whole, we feel that Shanghai Chlor-Alkali Chemical's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. To know the 3 risks we have identified for Shanghai Chlor-Alkali Chemical 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.