Suzhou Longway Eletronic Machinery's (SZSE:301202) stock is up by a considerable 32% over the past three months. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. Specifically, we decided to study Suzhou Longway Eletronic Machinery'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?

The formula for ROE is:

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

So, based on the above formula, the ROE for Suzhou Longway Eletronic Machinery is:

5.4% = CN¥64m ÷ CN¥1.2b (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.05 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. 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.

Suzhou Longway Eletronic Machinery's Earnings Growth And 5.4% ROE

When you first look at it, Suzhou Longway Eletronic Machinery's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 6.7%. We can see that Suzhou Longway Eletronic Machinery has grown at a five year net income growth average rate of 4.4%, which is a bit on the lower side. Remember, the company's ROE is not particularly great to begin with. Hence, this does provide some context to low earnings growth seen by the company.

As a next step, we compared Suzhou Longway Eletronic Machinery's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 15% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Suzhou Longway Eletronic Machinery's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Suzhou Longway Eletronic Machinery Using Its Retained Earnings Effectively?

Suzhou Longway Eletronic Machinery has a three-year median payout ratio of 61% (implying that it keeps only 39% of its profits), meaning that it pays out most of its profits to shareholders as dividends, and as a result, the company has seen low earnings growth.

Additionally, Suzhou Longway Eletronic Machinery started paying a dividend only recently. So it looks like the management must have perceived that shareholders favor dividends over earnings growth.

Conclusion

On the whole, Suzhou Longway Eletronic Machinery's performance is quite a big let-down. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. In brief, we think the company is risky and investors should think twice before making any final judgement on this company. You can see the 2 risks we have identified for Suzhou Longway Eletronic Machinery by visiting our risks dashboard for free on our platform here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.