Shanghai National Center of Testing and Inspection for Electric Cable and Wire (SZSE:301289) has had a rough three months with its share price down 17%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Shanghai National Center of Testing and Inspection for Electric Cable and Wire's ROE today.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Shanghai National Center of Testing and Inspection for Electric Cable and Wire is:

8.2% = CN¥81m ÷ CN¥988m (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¥0.08.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Shanghai National Center of Testing and Inspection for Electric Cable and Wire's Earnings Growth And 8.2% ROE

When you first look at it, Shanghai National Center of Testing and Inspection for Electric Cable and Wire's ROE doesn't look that attractive. However, its ROE is similar to the industry average of 7.1%, so we won't completely dismiss the company. Even so, Shanghai National Center of Testing and Inspection for Electric Cable and Wire has shown a fairly decent growth in its net income which grew at a rate of 8.2%. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's 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.

We then compared Shanghai National Center of Testing and Inspection for Electric Cable and Wire's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 3.9% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Shanghai National Center of Testing and Inspection for Electric Cable and Wire is trading on a high P/E or a low P/E, relative to its industry.

Is Shanghai National Center of Testing and Inspection for Electric Cable and Wire Making Efficient Use Of Its Profits?

Shanghai National Center of Testing and Inspection for Electric Cable and Wire has a three-year median payout ratio of 33%, which implies that it retains the remaining 67% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

While Shanghai National Center of Testing and Inspection for Electric Cable and Wire 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.

Summary

On the whole, we do feel that Shanghai National Center of Testing and Inspection for Electric Cable and Wire has some positive attributes. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. 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 2 risks we have identified for Shanghai National Center of Testing and Inspection for Electric Cable and Wire 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.