Shanghai Daimay Automotive Interior's (SHSE:603730) stock is up by 4.4% over the past week. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to investigate if the company's decent financials had a hand to play in the recent price move. Particularly, we will be paying attention to Shanghai Daimay Automotive Interior's ROE today.

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?

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 Shanghai Daimay Automotive Interior is:

15% = CN¥695m ÷ CN¥4.7b (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.15 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Shanghai Daimay Automotive Interior's Earnings Growth And 15% ROE

To begin with, Shanghai Daimay Automotive Interior seems to have a respectable ROE. Especially when compared to the industry average of 8.1% the company's ROE looks pretty impressive. Given the circumstances, we can't help but wonder why Shanghai Daimay Automotive Interior saw little to no growth in the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. These include low earnings retention or poor allocation of capital.

Next, on comparing with the industry net income growth, we found that Shanghai Daimay Automotive Interior's reported growth was lower than the industry growth of 8.4% over the last few years, which is not something we like to see.

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Shanghai Daimay Automotive Interior fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Shanghai Daimay Automotive Interior Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 78% (meaning, the company retains only 22% of profits) for Shanghai Daimay Automotive Interior suggests that the company's earnings growth was miniscule as a result of paying out a majority of its earnings.

In addition, Shanghai Daimay Automotive Interior has been paying dividends over a period of six years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 62% over the next three years. As a result, the expected drop in Shanghai Daimay Automotive Interior's payout ratio explains the anticipated rise in the company's future ROE to 20%, over the same period.

Summary

On the whole, we do feel that Shanghai Daimay Automotive Interior has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.

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