Zhejiang Shuanghuan DrivelineLtd (SZSE:002472) has had a great run on the share market with its stock up by a significant 17% over the last three months. Since the market usually pay for a company's long-term fundamentals, we decided to study the company's key performance indicators to see if they could be influencing the market. Particularly, we will be paying attention to Zhejiang Shuanghuan DrivelineLtd's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How To 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 Zhejiang Shuanghuan DrivelineLtd is:

10% = CN¥834m ÷ CN¥8.3b (Based on the trailing twelve months to December 2023).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.10 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. 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. 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.

A Side By Side comparison of Zhejiang Shuanghuan DrivelineLtd's Earnings Growth And 10% ROE

When you first look at it, Zhejiang Shuanghuan DrivelineLtd's ROE doesn't look that attractive. Although a closer study shows that the company's ROE is higher than the industry average of 8.0% which we definitely can't overlook. Especially when you consider Zhejiang Shuanghuan DrivelineLtd's exceptional 48% net income growth over the past five years. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. So, there might well be other reasons for the earnings to grow. Such as- high earnings retention or the company belonging to a high growth industry.

We then compared Zhejiang Shuanghuan DrivelineLtd's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 6.2% in the same 5-year period.

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. This then helps them determine if the stock is placed for a bright or bleak future. 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 Zhejiang Shuanghuan DrivelineLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Zhejiang Shuanghuan DrivelineLtd Making Efficient Use Of Its Profits?

Zhejiang Shuanghuan DrivelineLtd has a really low three-year median payout ratio of 10%, meaning that it has the remaining 90% left over to reinvest into its business. So it looks like Zhejiang Shuanghuan DrivelineLtd is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Besides, Zhejiang Shuanghuan DrivelineLtd has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 16% over the next three years. Regardless, the future ROE for Zhejiang Shuanghuan DrivelineLtd is speculated to rise to 13% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.

Conclusion

In total, we are pretty happy with Zhejiang Shuanghuan DrivelineLtd's performance. In particular, it's great to see that the company has seen significant growth in its earnings backed by a respectable ROE and a high reinvestment rate. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.