It is hard to get excited after looking at Meitu's (HKG:1357) recent performance, when its stock has declined 22% over the past three months. However, stock prices are usually driven by a company's financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Meitu's ROE in this article.

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 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 Meitu is:

8.9% = CN¥366m ÷ CN¥4.1b (Based on the trailing twelve months to December 2023).

The 'return' refers to a company's earnings over the last year. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.09.

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.

Meitu's Earnings Growth And 8.9% ROE

On the face of it, Meitu's ROE is not much to talk about. However, its ROE is similar to the industry average of 8.8%, so we won't completely dismiss the company. Moreover, we are quite pleased to see that Meitu's net income grew significantly at a rate of 72% over the last five years. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

Given that the industry shrunk its earnings at a rate of 10% over the last few years, the net income growth of the company is quite impressive.

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 Meitu's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Meitu Using Its Retained Earnings Effectively?

Meitu's ' three-year median payout ratio is on the lower side at 23% implying that it is retaining a higher percentage (77%) of its profits. So it looks like Meitu is reinvesting profits heavily to grow its business, which shows in its earnings growth.

While Meitu has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend.

Conclusion

Overall, we feel that Meitu certainly does have some positive factors to consider. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com