With its stock down 20% over the past three months, it is easy to disregard Shanghai Kelai Mechatronics EngineeringLtd (SHSE:603960). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Shanghai Kelai Mechatronics EngineeringLtd'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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

How Is ROE Calculated?

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 Shanghai Kelai Mechatronics EngineeringLtd is:

8.3% = CN¥91m ÷ CN¥1.1b (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.08 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

Shanghai Kelai Mechatronics EngineeringLtd's Earnings Growth And 8.3% ROE

At first glance, Shanghai Kelai Mechatronics EngineeringLtd's ROE doesn't look very promising. Although a closer study shows that the company's ROE is higher than the industry average of 6.9% which we definitely can't overlook. But seeing Shanghai Kelai Mechatronics EngineeringLtd's five year net income decline of 8.2% over the past five years, we might rethink that. Remember, the company's ROE is a bit low to begin with, just that it is higher than the industry average. Hence, this goes some way in explaining the shrinking earnings.

So, as a next step, we compared Shanghai Kelai Mechatronics EngineeringLtd's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 9.5% over the last few years.

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is 603960 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Shanghai Kelai Mechatronics EngineeringLtd Efficiently Re-investing Its Profits?

In spite of a normal three-year median payout ratio of 31% (that is, a retention ratio of 69%), the fact that Shanghai Kelai Mechatronics EngineeringLtd's earnings have shrunk is quite puzzling. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Additionally, Shanghai Kelai Mechatronics EngineeringLtd has paid dividends over a period of seven years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Conclusion

On the whole, we do feel that Shanghai Kelai Mechatronics EngineeringLtd has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a moderate ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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.

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