Most readers would already be aware that Shanxi Lu'an Environmental Energy Development's (SHSE:601699) stock increased significantly by 31% over the past month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Shanxi Lu'an Environmental Energy Development'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?

The formula for ROE is:

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

So, based on the above formula, the ROE for Shanxi Lu'an Environmental Energy Development is:

12% = CN¥6.0b ÷ CN¥48b (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.12 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 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.

Shanxi Lu'an Environmental Energy Development's Earnings Growth And 12% ROE

To start with, Shanxi Lu'an Environmental Energy Development's ROE looks acceptable. On comparing with the average industry ROE of 9.5% the company's ROE looks pretty remarkable. This probably laid the ground for Shanxi Lu'an Environmental Energy Development's significant 31% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Shanxi Lu'an Environmental Energy Development's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 19%.

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. What is 601699 worth today? The intrinsic value infographic in our free research report helps visualize whether 601699 is currently mispriced by the market.

Is Shanxi Lu'an Environmental Energy Development Using Its Retained Earnings Effectively?

Shanxi Lu'an Environmental Energy Development's significant three-year median payout ratio of 56% (where it is retaining only 44% of its income) suggests that the company has been able to achieve a high growth in earnings despite returning most of its income to shareholders.

Besides, Shanxi Lu'an Environmental Energy Development has been paying dividends over a period of nine years. This shows that the company is committed to sharing profits with its shareholders.

Conclusion

In total, we are pretty happy with Shanxi Lu'an Environmental Energy Development's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.