It is hard to get excited after looking at iSoftStone Information Technology (Group)'s (SZSE:301236) recent performance, when its stock has declined 21% over the past three months. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on iSoftStone Information Technology (Group)'s ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How To Calculate Return On Equity?

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 iSoftStone Information Technology (Group) is:

4.6% = CN¥487m ÷ CN¥11b (Based on the trailing twelve months to December 2023).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.05 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. 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.

iSoftStone Information Technology (Group)'s Earnings Growth And 4.6% ROE

It is hard to argue that iSoftStone Information Technology (Group)'s ROE is much good in and of itself. A comparison with the industry shows that the company's ROE is pretty similar to the average industry ROE of 5.2%. Therefore, the low net income growth of 3.7% seen by iSoftStone Information Technology (Group) over the past five years could probably be the result of it having a lower ROE.

As a next step, we compared iSoftStone Information Technology (Group)'s net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 3.7% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if iSoftStone Information Technology (Group) is trading on a high P/E or a low P/E, relative to its industry.

Is iSoftStone Information Technology (Group) Making Efficient Use Of Its Profits?

While iSoftStone Information Technology (Group) has a decent three-year median payout ratio of 31% (or a retention ratio of 69%), it has seen very little growth in earnings. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

In addition, iSoftStone Information Technology (Group) only recently started paying a dividend so the management must have decided the shareholders prefer dividends over earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 25% over the next three years. The fact that the company's ROE is expected to rise to 8.8% over the same period is explained by the drop in the payout ratio.

Summary

In total, it does look like iSoftStone Information Technology (Group) has some positive aspects to its business. Specifically, its fairly high earnings growth number, which no doubt was backed by the company's high earnings retention. Still, the low ROE means that all that reinvestment is not reaping a lot of benefit to the investors. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.

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