Wuxi Double Elephant Micro Fibre MaterialLtd's (SZSE:002395) stock is up by a considerable 41% over the past three months. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. In this article, we decided to focus on Wuxi Double Elephant Micro Fibre MaterialLtd's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

How To Calculate Return On Equity?

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 Wuxi Double Elephant Micro Fibre MaterialLtd is:

7.2% = CN¥67m ÷ CN¥934m (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.07 in profit.

What Has ROE Got To Do With 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. 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.

Wuxi Double Elephant Micro Fibre MaterialLtd's Earnings Growth And 7.2% ROE

When you first look at it, Wuxi Double Elephant Micro Fibre MaterialLtd's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 6.3%. But then again, Wuxi Double Elephant Micro Fibre MaterialLtd's five year net income shrunk at a rate of 14%. Bear in mind, the company does have a slightly low ROE. So that's what might be causing earnings growth to shrink.

That being said, we compared Wuxi Double Elephant Micro Fibre MaterialLtd's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 7.8% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. 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 Wuxi Double Elephant Micro Fibre MaterialLtd fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Wuxi Double Elephant Micro Fibre MaterialLtd Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 58% (implying that 42% of the profits are retained), most of Wuxi Double Elephant Micro Fibre MaterialLtd's profits are being paid to shareholders, which explains the company's shrinking earnings. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. You can see the 3 risks we have identified for Wuxi Double Elephant Micro Fibre MaterialLtd by visiting our risks dashboard for free on our platform here.

In addition, Wuxi Double Elephant Micro Fibre MaterialLtd has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Summary

Overall, we would be extremely cautious before making any decision on Wuxi Double Elephant Micro Fibre MaterialLtd. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. To gain further insights into Wuxi Double Elephant Micro Fibre MaterialLtd's past profit growth, check out this visualization of past earnings, revenue and cash flows.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.