Union Semiconductor (Hefei) (SHSE:688403) has had a great run on the share market with its stock up by a significant 37% over the last three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Union Semiconductor (Hefei)'s ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How Is ROE Calculated?

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 Union Semiconductor (Hefei) is:

4.9% = CN¥155m ÷ CN¥3.1b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. 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?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Union Semiconductor (Hefei)'s Earnings Growth And 4.9% ROE

When you first look at it, Union Semiconductor (Hefei)'s ROE doesn't look that attractive. Next, when compared to the average industry ROE of 6.4%, the company's ROE leaves us feeling even less enthusiastic. Despite this, surprisingly, Union Semiconductor (Hefei) saw an exceptional 37% net income growth over the past five years. We reckon that there could be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Union Semiconductor (Hefei)'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 14%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Union Semiconductor (Hefei) is trading on a high P/E or a low P/E, relative to its industry.

Is Union Semiconductor (Hefei) Using Its Retained Earnings Effectively?

The three-year median payout ratio for Union Semiconductor (Hefei) is 47%, which is moderately low. The company is retaining the remaining 53%. By the looks of it, the dividend is well covered and Union Semiconductor (Hefei) is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Summary

On the whole, we do feel that Union Semiconductor (Hefei) has some positive attributes. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. 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. You can see the 1 risk we have identified for Union Semiconductor (Hefei) by visiting our risks dashboard for free on our platform here.

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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.