With its stock down 17% over the past week, it is easy to disregard Lafang ChinaLtd (SHSE:603630). We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Stock prices are usually driven by a company's financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Particularly, we will be paying attention to Lafang ChinaLtd's ROE today.

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. 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 Lafang ChinaLtd is:

1.9% = CN¥38m ÷ CN¥2.0b (Based on the trailing twelve months to September 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.02 in profit.

What Is The Relationship Between ROE And 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.

A Side By Side comparison of Lafang ChinaLtd's Earnings Growth And 1.9% ROE

As you can see, Lafang ChinaLtd's ROE looks pretty weak. Even compared to the average industry ROE of 4.1%, the company's ROE is quite dismal. Hence, the flat earnings seen by Lafang ChinaLtd over the past five years could probably be the result of it having a lower ROE.

From the 1.9% decline reported by the industry in the same period, we infer that Lafang ChinaLtd and its industry are both shrinking at a similar rate.

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Lafang ChinaLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Lafang ChinaLtd Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 50% (implying that the company keeps only 50% of its income) of its business to reinvest into its business), most of Lafang ChinaLtd's profits are being paid to shareholders, which explains the absence of growth in earnings.

Moreover, Lafang ChinaLtd has been paying dividends for eight years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Conclusion

Overall, we have mixed feelings about Lafang ChinaLtd. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. So far, we've only made a quick discussion around the company's earnings growth. To gain further insights into Lafang ChinaLtd's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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.