Shanghai Baolong Automotive (SHSE:603197) has had a rough three months with its share price down 12%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Shanghai Baolong Automotive's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Is ROE Calculated?

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 Shanghai Baolong Automotive is:

14% = CN¥438m ÷ CN¥3.1b (Based on the trailing twelve months to September 2023).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.14 in profit.

Why Is ROE Important For Earnings Growth?

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

A Side By Side comparison of Shanghai Baolong Automotive's Earnings Growth And 14% ROE

At first glance, Shanghai Baolong Automotive seems to have a decent ROE. Especially when compared to the industry average of 7.5% the company's ROE looks pretty impressive. This probably laid the ground for Shanghai Baolong Automotive's moderate 17% net income growth seen over the past five years.

As a next step, we compared Shanghai Baolong Automotive'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 4.1%.

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is 603197 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Shanghai Baolong Automotive Efficiently Re-investing Its Profits?

With a three-year median payout ratio of 27% (implying that the company retains 73% of its profits), it seems that Shanghai Baolong Automotive is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Additionally, Shanghai Baolong Automotive has paid dividends over a period of seven years which means that the company is pretty serious about sharing its profits with shareholders.

Conclusion

In total, we are pretty happy with Shanghai Baolong Automotive's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.