Sunshine Global CircuitsLtd (SZSE:300739) has had a rough three months with its share price down 28%. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. In this article, we decided to focus on Sunshine Global CircuitsLtd's ROE.

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. 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?

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 Sunshine Global CircuitsLtd is:

6.1% = CN¥115m ÷ CN¥1.9b (Based on the trailing twelve months to September 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¥0.06 in profit.

What Is The Relationship Between ROE And Earnings Growth?

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

Sunshine Global CircuitsLtd's Earnings Growth And 6.1% ROE

On the face of it, Sunshine Global CircuitsLtd's ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 6.7%. We can see that Sunshine Global CircuitsLtd has grown at a five year net income growth average rate of 3.3%, which is a bit on the lower side. Remember, the company's ROE is not particularly great to begin with. So this could also be one of the reasons behind the company's low growth in earnings.

Next, on comparing with the industry net income growth, we found that Sunshine Global CircuitsLtd's reported growth was lower than the industry growth of 11% over the last few years, which is not something we like to see.

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. Doing so will help them establish if the stock's future looks promising or ominous. 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 Sunshine Global CircuitsLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Sunshine Global CircuitsLtd Using Its Retained Earnings Effectively?

Sunshine Global CircuitsLtd has a three-year median payout ratio of 65% (implying that it keeps only 35% of its profits), meaning that it pays out most of its profits to shareholders as dividends, and as a result, the company has seen low earnings growth.

Moreover, Sunshine Global CircuitsLtd has been paying dividends for six years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Conclusion

Overall, we would be extremely cautious before making any decision on Sunshine Global CircuitsLtd. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. In brief, we think the company is risky and investors should think twice before making any final judgement on this company. To know the 2 risks we have identified for Sunshine Global CircuitsLtd 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.