Shanghai Chlor-Alkali Chemical (SHSE:600618) has had a rough month with its share price down 5.2%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Shanghai Chlor-Alkali Chemical's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How To Calculate Return On Equity?

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 Shanghai Chlor-Alkali Chemical is:

9.2% = CN¥823m ÷ CN¥8.9b (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¥0.09 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. 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. 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 Shanghai Chlor-Alkali Chemical's Earnings Growth And 9.2% ROE

On the face of it, Shanghai Chlor-Alkali Chemical's ROE is not much to talk about. Although a closer study shows that the company's ROE is higher than the industry average of 6.3% which we definitely can't overlook. However, Shanghai Chlor-Alkali Chemical's five year net income growth was quite low averaging at only 4.4%. Remember, the company's ROE is quite low to begin with, just that it is higher than the industry average. So that could be one of the factors that are causing earnings growth to stay low.

We then compared Shanghai Chlor-Alkali Chemical's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 7.8% in the same 5-year period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. 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. Is Shanghai Chlor-Alkali Chemical fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Shanghai Chlor-Alkali Chemical Efficiently Re-investing Its Profits?

Despite having a moderate three-year median payout ratio of 26% (implying that the company retains the remaining 74% of its income), Shanghai Chlor-Alkali Chemical's earnings growth was quite low. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, Shanghai Chlor-Alkali Chemical has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Conclusion

On the whole, we do feel that Shanghai Chlor-Alkali Chemical has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a moderate ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 2 risks we have identified for Shanghai Chlor-Alkali Chemical 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.

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