Shenzhen Longtech Smart Control (SZSE:300916) has had a great run on the share market with its stock up by a significant 53% 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. Specifically, we decided to study Shenzhen Longtech Smart Control'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How Is ROE Calculated?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Shenzhen Longtech Smart Control is:

11% = CN¥145m ÷ CN¥1.3b (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.11.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

A Side By Side comparison of Shenzhen Longtech Smart Control's Earnings Growth And 11% ROE

At first glance, Shenzhen Longtech Smart Control seems to have a decent ROE. Especially when compared to the industry average of 6.3% the company's ROE looks pretty impressive. This probably laid the ground for Shenzhen Longtech Smart Control's moderate 18% net income growth seen over the past five years.

As a next step, we compared Shenzhen Longtech Smart Control's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 6.4%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 Shenzhen Longtech Smart Control is trading on a high P/E or a low P/E, relative to its industry.

Is Shenzhen Longtech Smart Control Using Its Retained Earnings Effectively?

In Shenzhen Longtech Smart Control's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 15% (or a retention ratio of 85%), which suggests that the company is investing most of its profits to grow its business.

Moreover, Shenzhen Longtech Smart Control is determined to keep sharing its profits with shareholders which we infer from its long history of three years of paying a dividend.

Summary

On the whole, we feel that Shenzhen Longtech Smart Control's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. You can see the 2 risks we have identified for Shenzhen Longtech Smart Control 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.