North Electro-OpticLtd's (SHSE:600184) stock is up by a considerable 19% over the past month. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Specifically, we decided to study North Electro-OpticLtd's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.

How Do You Calculate Return On Equity?

ROE 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 North Electro-OpticLtd is:

1.7% = CN¥43m ÷ CN¥2.5b (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.02.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

North Electro-OpticLtd's Earnings Growth And 1.7% ROE

It is quite clear that North Electro-OpticLtd's ROE is rather low. Even when compared to the industry average of 4.8%, the ROE figure is pretty disappointing. As a result, North Electro-OpticLtd's flat earnings over the past five years doesn't come as a surprise given its lower ROE.

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

Earnings growth is an important metric to consider when valuing a stock. 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. If you're wondering about North Electro-OpticLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is North Electro-OpticLtd Efficiently Re-investing Its Profits?

Despite having a moderate three-year median payout ratio of 41% (meaning the company retains59% of profits) in the last three-year period, North Electro-OpticLtd's earnings growth was more or les flat. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, North Electro-OpticLtd has paid dividends over a period of eight years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 42%. Still, forecasts suggest that North Electro-OpticLtd's future ROE will rise to 3.2% even though the the company's payout ratio is not expected to change by much.

Conclusion

In total, we're a bit ambivalent about North Electro-OpticLtd's performance. 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. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.