Innuovo Technology (SZSE:000795) has had a rough three months with its share price down 13%. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Particularly, we will be paying attention to Innuovo Technology's ROE today.

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. 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 Innuovo Technology is:

4.5% = CN¥121m ÷ CN¥2.7b (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¥0.04 in profit.

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. 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.

Innuovo Technology's Earnings Growth And 4.5% ROE

It is quite clear that Innuovo Technology's ROE is rather low. Even when compared to the industry average of 7.4%, the ROE figure is pretty disappointing. Accordingly, Innuovo Technology's low net income growth of 4.2% over the past five years can possibly be explained by the low ROE amongst other factors.

Next, on comparing with the industry net income growth, we found that Innuovo Technology's reported growth was lower than the industry growth of 11% over the last few years, which is not something we like to see.

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. 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 Innuovo Technology is trading on a high P/E or a low P/E, relative to its industry.

Is Innuovo Technology Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 36% (or a retention ratio of 64% over the past three years, Innuovo Technology has seen very little growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, Innuovo Technology started paying a dividend only recently. So it looks like the management must have perceived that shareholders favor dividends over earnings growth.

Conclusion

On the whole, we feel that the performance shown by Innuovo Technology can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. You can see the 1 risk we have identified for Innuovo Technology by visiting our risks dashboard for free on our platform here.

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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