Shanghai Allied Industrial (SZSE:301419) has had a great run on the share market with its stock up by a significant 21% over the last week. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. In this article, we decided to focus on Shanghai Allied Industrial's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How To 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 Shanghai Allied Industrial is:

3.5% = CN¥32m ÷ CN¥919m (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.04.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

A Side By Side comparison of Shanghai Allied Industrial's Earnings Growth And 3.5% ROE

It is quite clear that Shanghai Allied Industrial's ROE is rather low. Not just that, even compared to the industry average of 7.0%, the company's ROE is entirely unremarkable. As a result, Shanghai Allied Industrial's flat earnings over the past five years doesn't come as a surprise given its lower ROE.

As a next step, we compared Shanghai Allied Industrial's net income growth with the industry and discovered that the industry saw an average growth of 12% in the same period.

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. Doing so will help them establish if the stock's future looks promising or ominous. Is Shanghai Allied Industrial fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Shanghai Allied Industrial Efficiently Re-investing Its Profits?

Shanghai Allied Industrial has a high three-year median payout ratio of 54% (or a retention ratio of 46%), meaning that the company is paying most of its profits as dividends to its shareholders. This does go some way in explaining why there's been no growth in its earnings.

Only recently, Shanghai Allied Industrial started paying a dividend. This means that the management might have concluded that its shareholders prefer dividends over earnings growth.

Summary

On the whole, Shanghai Allied Industrial's performance is quite a big let-down. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. So far, we've only made a quick discussion around the company's earnings growth. You can do your own research on Shanghai Allied Industrial 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.