Xiamen Faratronic's (SHSE:600563) stock is up by a considerable 26% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Xiamen Faratronic'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 Xiamen Faratronic is:

23% = CN¥1.0b ÷ CN¥4.4b (Based on the trailing twelve months to September 2023).

The 'return' is the income the business earned over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.23 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. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

Xiamen Faratronic's Earnings Growth And 23% ROE

To begin with, Xiamen Faratronic has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 6.7% the company's ROE is quite impressive. So, the substantial 22% net income growth seen by Xiamen Faratronic over the past five years isn't overly surprising.

As a next step, we compared Xiamen Faratronic'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 11%.

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). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Xiamen Faratronic's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Xiamen Faratronic Using Its Retained Earnings Effectively?

The three-year median payout ratio for Xiamen Faratronic is 40%, which is moderately low. The company is retaining the remaining 60%. By the looks of it, the dividend is well covered and Xiamen Faratronic is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Additionally, Xiamen Faratronic has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 43%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 25%.

Conclusion

On the whole, we feel that Xiamen Faratronic's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.