NanJing Sanchao Advanced MaterialsLtd (SZSE:300554) has had a great run on the share market with its stock up by a significant 15% over the last week. 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 NanJing Sanchao Advanced MaterialsLtd's ROE.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

How To Calculate Return On Equity?

Return on equity 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 NanJing Sanchao Advanced MaterialsLtd is:

3.2% = CN¥26m ÷ CN¥824m (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.03 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.

NanJing Sanchao Advanced MaterialsLtd's Earnings Growth And 3.2% ROE

As you can see, NanJing Sanchao Advanced MaterialsLtd's ROE looks pretty weak. Not just that, even compared to the industry average of 5.8%, the company's ROE is entirely unremarkable. NanJing Sanchao Advanced MaterialsLtd was still able to see a decent net income growth of 5.1% over the past five years. Therefore, the growth in earnings could probably have been caused by other variables. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that NanJing Sanchao Advanced MaterialsLtd's reported growth was lower than the industry growth of 20% over the last few years, which is not something we like to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 NanJing Sanchao Advanced MaterialsLtd is trading on a high P/E or a low P/E, relative to its industry.

Is NanJing Sanchao Advanced MaterialsLtd Efficiently Re-investing Its Profits?

With a three-year median payout ratio of 31% (implying that the company retains 69% of its profits), it seems that NanJing Sanchao Advanced MaterialsLtd is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Additionally, NanJing Sanchao Advanced MaterialsLtd has paid dividends over a period of six years which means that the company is pretty serious about sharing its profits with shareholders.

Conclusion

On the whole, we do feel that NanJing Sanchao Advanced MaterialsLtd has some positive attributes. Specifically, its fairly high earnings growth number, which no doubt was backed by the company's high earnings retention. Still, the low ROE means that all that reinvestment is not reaping a lot of benefit to the investors. 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. Our risks dashboard will have the 1 risk we have identified for NanJing Sanchao Advanced MaterialsLtd.

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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