With its stock down 18% over the past week, it is easy to disregard Sanyou (SZSE:300932). We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Particularly, we will be paying attention to Sanyou'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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Is ROE Calculated?

Return on equity 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 Sanyou is:

2.7% = CN¥47m ÷ CN¥1.8b (Based on the trailing twelve months to March 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¥0.03 in profit.

Why Is ROE Important For Earnings Growth?

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

Sanyou's Earnings Growth And 2.7% ROE

It is quite clear that Sanyou's ROE is rather low. Even compared to the average industry ROE of 6.9%, the company's ROE is quite dismal. Given the circumstances, the significant decline in net income by 28% seen by Sanyou over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.

That being said, we compared Sanyou'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 12% 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. Doing so will help them establish if the stock's future looks promising or ominous. 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 Sanyou is trading on a high P/E or a low P/E, relative to its industry.

Is Sanyou Making Efficient Use Of Its Profits?

Despite having a normal three-year median payout ratio of 35% (where it is retaining 65% of its profits), Sanyou has seen a decline in earnings as we saw above. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Moreover, Sanyou has been paying dividends for three 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 Sanyou's performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. 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. To know the 5 risks we have identified for Sanyou visit our risks dashboard for free.

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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.