Southchip Semiconductor Technology(Shanghai)'s (SHSE:688484) stock is up by a considerable 20% over the past three months. Since the market usually pay for a company's long-term fundamentals, we decided to study the company's key performance indicators to see if they could be influencing the market. Specifically, we decided to study Southchip Semiconductor Technology(Shanghai)'s 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 Do You 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 Southchip Semiconductor Technology(Shanghai) is:

8.6% = CN¥331m ÷ CN¥3.8b (Based on the trailing twelve months to March 2024).

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¥0.09 in profit.

Why Is ROE Important For 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. 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 Southchip Semiconductor Technology(Shanghai)'s Earnings Growth And 8.6% ROE

When you first look at it, Southchip Semiconductor Technology(Shanghai)'s ROE doesn't look that attractive. However, the fact that the company's ROE is higher than the average industry ROE of 5.8%, is definitely interesting. Even more so after seeing Southchip Semiconductor Technology(Shanghai)'s exceptional 38% net income growth over the past five years. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. Hence, there might be some other aspects that are causing earnings to grow. E.g the company has a low payout ratio or could belong to a high growth industry.

As a next step, we compared Southchip Semiconductor Technology(Shanghai)'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 20%.

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). This then helps them determine if the stock is placed for a bright or bleak future. 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 Southchip Semiconductor Technology(Shanghai) is trading on a high P/E or a low P/E, relative to its industry.

Is Southchip Semiconductor Technology(Shanghai) Efficiently Re-investing Its Profits?

The three-year median payout ratio for Southchip Semiconductor Technology(Shanghai) is 43%, which is moderately low. The company is retaining the remaining 57%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Southchip Semiconductor Technology(Shanghai) is reinvesting its earnings efficiently.

While Southchip Semiconductor Technology(Shanghai) has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend.

Conclusion

In total, we are pretty happy with Southchip Semiconductor Technology(Shanghai)'s performance. In particular, it's great to see that the company has seen significant growth in its earnings backed by a respectable ROE and a high reinvestment rate. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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