Nextool Technology (SHSE:688419) has had a great run on the share market with its stock up by a significant 14% over the last month. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Nextool Technology'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.

View our latest analysis for Nextool Technology

How Is ROE Calculated?

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 Nextool Technology is:

4.8% = CN¥45m ÷ CN¥950m (Based on the trailing twelve months to September 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¥0.05.

What Is The Relationship Between ROE And 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.

Nextool Technology's Earnings Growth And 4.8% ROE

It is quite clear that Nextool Technology's ROE is rather low. Even when compared to the industry average of 6.1%, the ROE figure is pretty disappointing. In spite of this, Nextool Technology was able to grow its net income considerably, at a rate of 23% in the last five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Nextool Technology's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 28% in the same period.

Earnings growth is a huge factor in stock valuation. 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. If you're wondering about Nextool Technology's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Nextool Technology Efficiently Re-investing Its Profits?

Nextool Technology's three-year median payout ratio is a pretty moderate 37%, meaning the company retains 63% of its income. By the looks of it, the dividend is well covered and Nextool Technology is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Summary

In total, it does look like Nextool Technology has some positive aspects to its business. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. 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. To know the 3 risks we have identified for Nextool Technology visit our risks dashboard for free.

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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.