Shanghai Chicmax Cosmetic (HKG:2145) has had a great run on the share market with its stock up by a significant 33% over the last month. 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. In this article, we decided to focus on Shanghai Chicmax Cosmetic's ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

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 Chicmax Cosmetic is:

36% = CN¥773m ÷ CN¥2.1b (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every HK$1 worth of equity, the company was able to earn HK$0.36 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. 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.

A Side By Side comparison of Shanghai Chicmax Cosmetic's Earnings Growth And 36% ROE

Firstly, we acknowledge that Shanghai Chicmax Cosmetic has a significantly high ROE. Secondly, even when compared to the industry average of 9.5% the company's ROE is quite impressive. So, the substantial 35% net income growth seen by Shanghai Chicmax Cosmetic over the past five years isn't overly surprising.

Next, on comparing with the industry net income growth, we found that Shanghai Chicmax Cosmetic's growth is quite high when compared to the industry average growth of 10% in the same period, which is great to see.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Shanghai Chicmax Cosmetic's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shanghai Chicmax Cosmetic Making Efficient Use Of Its Profits?

Shanghai Chicmax Cosmetic has a significant three-year median payout ratio of 80%, meaning the company only retains 20% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.

While Shanghai Chicmax Cosmetic 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 66%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 42%.

Conclusion

Overall, we are quite pleased with Shanghai Chicmax Cosmetic's performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.