Most readers would already be aware that Yonyou Auto Information Technology (Shanghai)Ltd's (SHSE:688479) stock increased significantly by 46% over the past month. 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. Specifically, we decided to study Yonyou Auto Information Technology (Shanghai)Ltd's ROE in this article.

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 Do You 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 Yonyou Auto Information Technology (Shanghai)Ltd is:

4.5% = CN¥86m ÷ CN¥1.9b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.05 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

A Side By Side comparison of Yonyou Auto Information Technology (Shanghai)Ltd's Earnings Growth And 4.5% ROE

As you can see, Yonyou Auto Information Technology (Shanghai)Ltd's ROE looks pretty weak. An industry comparison shows that the company's ROE is not much different from the industry average of 4.5% either. Accordingly, Yonyou Auto Information Technology (Shanghai)Ltd's low net income growth of 4.3% over the past five years can possibly be explained by the low ROE amongst other factors.

As a next step, we compared Yonyou Auto Information Technology (Shanghai)Ltd'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 0.8%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Yonyou Auto Information Technology (Shanghai)Ltd is trading on a high P/E or a low P/E, relative to its industry.

Is Yonyou Auto Information Technology (Shanghai)Ltd Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 56% (that is, the company retains only 44% of its income) over the past three years for Yonyou Auto Information Technology (Shanghai)Ltd suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.

Conclusion

In total, it does look like Yonyou Auto Information Technology (Shanghai)Ltd has some positive aspects to its business. Namely, its high earnings growth. We do however feel that the earnings growth number could have been even higher, had the company been reinvesting more of its earnings and paid out less dividends. 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 Yonyou Auto Information Technology (Shanghai)Ltd 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.