Shenzhen Longood Intelligent ElectricLTD (SZSE:300543) has had a great run on the share market with its stock up by a significant 30% over the last three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to Shenzhen Longood Intelligent ElectricLTD's ROE today.

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 Is ROE Calculated?

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 Shenzhen Longood Intelligent ElectricLTD is:

3.6% = CN¥41m ÷ CN¥1.1b (Based on the trailing twelve months to June 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.

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. 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Shenzhen Longood Intelligent ElectricLTD's Earnings Growth And 3.6% ROE

As you can see, Shenzhen Longood Intelligent ElectricLTD's ROE looks pretty weak. Even compared to the average industry ROE of 6.4%, the company's ROE is quite dismal. For this reason, Shenzhen Longood Intelligent ElectricLTD's five year net income decline of 16% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

That being said, we compared Shenzhen Longood Intelligent ElectricLTD's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 4.6% in the same 5-year period.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Shenzhen Longood Intelligent ElectricLTD fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Shenzhen Longood Intelligent ElectricLTD Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 30% (where it is retaining 70% of its profits), Shenzhen Longood Intelligent ElectricLTD has seen a decline in earnings as we saw above. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, Shenzhen Longood Intelligent ElectricLTD has been paying dividends for seven years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking.

Conclusion

In total, we're a bit ambivalent about Shenzhen Longood Intelligent ElectricLTD'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. 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 3 risks we have identified for Shenzhen Longood Intelligent ElectricLTD 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.