It is hard to get excited after looking at Dongguan Yiheda Automation's (SZSE:301029) recent performance, when its stock has declined 25% over the past three months. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Dongguan Yiheda Automation's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How To Calculate Return On Equity?

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 Dongguan Yiheda Automation is:

18% = CN¥546m ÷ CN¥3.0b (Based on the trailing twelve months to December 2023).

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¥0.18.

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. 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.

Dongguan Yiheda Automation's Earnings Growth And 18% ROE

To begin with, Dongguan Yiheda Automation seems to have a respectable ROE. On comparing with the average industry ROE of 6.9% the company's ROE looks pretty remarkable. This certainly adds some context to Dongguan Yiheda Automation's exceptional 26% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Dongguan Yiheda Automation's growth is quite high when compared to the industry average growth of 9.5% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is Dongguan Yiheda Automation fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Dongguan Yiheda Automation Using Its Retained Earnings Effectively?

Dongguan Yiheda Automation's three-year median payout ratio is a pretty moderate 26%, meaning the company retains 74% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Dongguan Yiheda Automation is reinvesting its earnings efficiently.

While Dongguan Yiheda Automation has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 37% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.

Summary

In total, we are pretty happy with Dongguan Yiheda Automation's performance. 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. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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