Zhejiang Songyuan Automotive Safety SystemsLtd (SZSE:300893) has had a rough month with its share price down 13%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Zhejiang Songyuan Automotive Safety SystemsLtd'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 Do You Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Zhejiang Songyuan Automotive Safety SystemsLtd is:

20% = CN¥226m ÷ CN¥1.1b (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¥0.20 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. 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.

Zhejiang Songyuan Automotive Safety SystemsLtd's Earnings Growth And 20% ROE

To begin with, Zhejiang Songyuan Automotive Safety SystemsLtd seems to have a respectable ROE. Especially when compared to the industry average of 8.2% the company's ROE looks pretty impressive. This probably laid the ground for Zhejiang Songyuan Automotive Safety SystemsLtd's significant 23% net income growth seen over the past five years. We reckon that there could also be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

We then compared Zhejiang Songyuan Automotive Safety SystemsLtd's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 8.9% 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). This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for 300893? You can find out in our latest intrinsic value infographic research report.

Is Zhejiang Songyuan Automotive Safety SystemsLtd Making Efficient Use Of Its Profits?

Zhejiang Songyuan Automotive Safety SystemsLtd has a three-year median payout ratio of 27% (where it is retaining 73% of its income) which is not too low or not too high. By the looks of it, the dividend is well covered and Zhejiang Songyuan Automotive Safety SystemsLtd is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Additionally, Zhejiang Songyuan Automotive Safety SystemsLtd has paid dividends over a period of three years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 14% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 27%, over the same period.

Summary

Overall, we are quite pleased with Zhejiang Songyuan Automotive Safety SystemsLtd's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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