It is hard to get excited after looking at Shanxi Lanhua Sci-Tech VentureLtd's (SHSE:600123) recent performance, when its stock has declined 10% over the past month. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Shanxi Lanhua Sci-Tech VentureLtd's ROE today.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

How To 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 Shanxi Lanhua Sci-Tech VentureLtd is:

10% = CN¥1.6b ÷ CN¥16b (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.10.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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 Shanxi Lanhua Sci-Tech VentureLtd's Earnings Growth And 10% ROE

At first glance, Shanxi Lanhua Sci-Tech VentureLtd's ROE doesn't look very promising. However, its ROE is similar to the industry average of 9.8%, so we won't completely dismiss the company. Looking at Shanxi Lanhua Sci-Tech VentureLtd's exceptional 31% five-year net income growth in particular, we are definitely impressed. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. Such as - high earnings retention or an efficient management in place.

We then compared Shanxi Lanhua Sci-Tech VentureLtd's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 22% in the same 5-year period.

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 Shanxi Lanhua Sci-Tech VentureLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shanxi Lanhua Sci-Tech VentureLtd Efficiently Re-investing Its Profits?

The three-year median payout ratio for Shanxi Lanhua Sci-Tech VentureLtd is 35%, which is moderately low. The company is retaining the remaining 65%. By the looks of it, the dividend is well covered and Shanxi Lanhua Sci-Tech VentureLtd is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Besides, Shanxi Lanhua Sci-Tech VentureLtd has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.

Summary

In total, it does look like Shanxi Lanhua Sci-Tech VentureLtd has some positive aspects to its business. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.