Luenmei QuantumLtd (SHSE:600167) has had a great run on the share market with its stock up by a significant 16% over the last three months. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. Particularly, we will be paying attention to Luenmei QuantumLtd's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How To 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 Luenmei QuantumLtd is:

6.5% = CN¥772m ÷ CN¥12b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.07 in profit.

Why Is ROE Important For Earnings Growth?

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

Luenmei QuantumLtd's Earnings Growth And 6.5% ROE

On the face of it, Luenmei QuantumLtd's ROE is not much to talk about. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 8.5%. Therefore, it might not be wrong to say that the five year net income decline of 17% seen by Luenmei QuantumLtd was probably the result of it having a lower ROE. 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 Luenmei QuantumLtd'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 7.6% in the same 5-year period.

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). This then helps them determine if the stock is placed for a bright or bleak future. Is 600167 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Luenmei QuantumLtd Using Its Retained Earnings Effectively?

Luenmei QuantumLtd has a high three-year median payout ratio of 50% (that is, it is retaining 50% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run.

In addition, Luenmei QuantumLtd has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 54%. Regardless, the future ROE for Luenmei QuantumLtd is predicted to rise to 8.4% despite there being not much change expected in its payout ratio.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Luenmei QuantumLtd. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.