Feilong Auto Components (SZSE:002536) has had a rough three months with its share price down 13%. However, stock prices are usually driven by a company's financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Feilong Auto Components' 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 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 Feilong Auto Components is:

8.2% = CN¥262m ÷ CN¥3.2b (Based on the trailing twelve months to December 2023).

The 'return' refers to a company's earnings over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.08 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Feilong Auto Components' Earnings Growth And 8.2% ROE

On the face of it, Feilong Auto Components' ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.5%. Having said that, Feilong Auto Components has shown a meagre net income growth of 3.5% over the past five years. Bear in mind, the company's ROE is not very high . Hence, this does provide some context to low earnings growth seen by the company.

Next, on comparing Feilong Auto Components' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 4.1% over the last few years.

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. 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 Feilong Auto Components''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Feilong Auto Components Using Its Retained Earnings Effectively?

While Feilong Auto Components has a decent three-year median payout ratio of 45% (or a retention ratio of 55%), it has seen very little growth in earnings. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, Feilong Auto Components has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

In total, it does look like Feilong Auto Components has some positive aspects to its business. That is, a decent growth in earnings backed by a high rate of reinvestment. However, we do feel that that earnings growth could have been higher if the business were to improve on the low ROE rate. Especially given how the company is reinvesting a huge chunk of its profits. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 2 risks we have identified for Feilong Auto Components 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.