Sichuan Dawn Precision TechnologyLtd (SZSE:300780) has had a great run on the share market with its stock up by a significant 81% over the last month. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study Sichuan Dawn Precision TechnologyLtd's ROE in this article.

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 ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Sichuan Dawn Precision TechnologyLtd is:

2.9% = CN¥35m ÷ CN¥1.2b (Based on the trailing twelve months to September 2023).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.03 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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.

A Side By Side comparison of Sichuan Dawn Precision TechnologyLtd's Earnings Growth And 2.9% ROE

As you can see, Sichuan Dawn Precision TechnologyLtd's ROE looks pretty weak. Even compared to the average industry ROE of 7.5%, the company's ROE is quite dismal. Thus, the low net income growth of 3.8% seen by Sichuan Dawn Precision TechnologyLtd over the past five years could probably be the result of it having a lower ROE.

We then compared Sichuan Dawn Precision TechnologyLtd's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 11% in the same 5-year period, which is a bit concerning.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Sichuan Dawn Precision TechnologyLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Sichuan Dawn Precision TechnologyLtd Using Its Retained Earnings Effectively?

Sichuan Dawn Precision TechnologyLtd's low three-year median payout ratio of 20% (or a retention ratio of 80%) should mean that the company is retaining most of its earnings to fuel its growth. This should be reflected in its earnings growth number, but that's not the case. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

In addition, Sichuan Dawn Precision TechnologyLtd has been paying dividends over a period of four years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Conclusion

Overall, we have mixed feelings about Sichuan Dawn Precision TechnologyLtd. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. 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 4 risks we have identified for Sichuan Dawn Precision TechnologyLtd 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.