Shanghai Ziyan Foods' (SHSE:603057) stock is up by a considerable 9.5% over the past month. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Specifically, we decided to study Shanghai Ziyan Foods' 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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Shanghai Ziyan Foods is:

18% = CN¥363m ÷ CN¥2.0b (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.18 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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company's earnings growth potential. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Shanghai Ziyan Foods' Earnings Growth And 18% ROE

At first glance, Shanghai Ziyan Foods seems to have a decent ROE. On comparing with the average industry ROE of 8.0% the company's ROE looks pretty remarkable. Yet, Shanghai Ziyan Foods has posted measly growth of 3.4% over the past five years. That's a bit unexpected from a company which has such a high rate of return. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or poor allocation of capital.

Next, on comparing with the industry net income growth, we found that Shanghai Ziyan Foods' growth is quite high when compared to the industry average growth of 1.6% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. 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 Shanghai Ziyan Foods is trading on a high P/E or a low P/E, relative to its industry.

Is Shanghai Ziyan Foods Making Efficient Use Of Its Profits?

Shanghai Ziyan Foods has a very high three-year median payout ratio of 105%, which suggests that the company is dipping into more than just its profits to pay its dividend and that shows in its low earnings growth number. This is indicative of risk. Our risks dashboard should have the 2 risks we have identified for Shanghai Ziyan Foods.

Additionally, Shanghai Ziyan Foods started paying a dividend only recently. So it looks like the management must have perceived that shareholders favor dividends over earnings growth. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 89%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 21%.

Conclusion

Overall, we feel that Shanghai Ziyan Foods certainly does have some positive factors to consider. Especially the growth in earnings which was backed by an impressive ROE. Still, the high ROE could have been even more beneficial to investors had the company been reinvesting more of its profits. As highlighted earlier, the current reinvestment rate appears to be negligible. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.