With its stock down 12% over the past three months, it is easy to disregard Namchow Food Group (Shanghai) (SHSE:605339). We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. Particularly, we will be paying attention to Namchow Food Group (Shanghai)'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 Do You 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 Namchow Food Group (Shanghai) is:

7.6% = CN¥258m ÷ CN¥3.4b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.08 in profit.

Why Is ROE Important For Earnings Growth?

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

Namchow Food Group (Shanghai)'s Earnings Growth And 7.6% ROE

At first glance, Namchow Food Group (Shanghai)'s ROE doesn't look very promising. However, its ROE is similar to the industry average of 7.6%, so we won't completely dismiss the company. Having said that, Namchow Food Group (Shanghai)'s five year net income decline rate was 18%. Bear in mind, the company does have a slightly low ROE. Therefore, the decline in earnings could also be the result of this.

That being said, we compared Namchow Food Group (Shanghai)'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 2.5% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Namchow Food Group (Shanghai)'s's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Namchow Food Group (Shanghai) Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 62% (implying that 38% of the profits are retained), most of Namchow Food Group (Shanghai)'s profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 2 risks we have identified for Namchow Food Group (Shanghai) by visiting our risks dashboard for free on our platform here.

Additionally, Namchow Food Group (Shanghai) has paid dividends over a period of three years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Conclusion

Overall, we would be extremely cautious before making any decision on Namchow Food Group (Shanghai). As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. You can do your own research on Namchow Food Group (Shanghai) and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.

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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.