Shandong Shanda OumasoftLTD (SZSE:301185) has had a rough three months with its share price down 22%. However, stock prices are usually driven by a company's financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Shandong Shanda OumasoftLTD's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Shandong Shanda OumasoftLTD

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 Shandong Shanda OumasoftLTD is:

8.0% = CN¥80m ÷ CN¥1.0b (Based on the trailing twelve months to June 2023).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.08 in profit.

What Is The Relationship Between ROE And 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.

Shandong Shanda OumasoftLTD's Earnings Growth And 8.0% ROE

When you first look at it, Shandong Shanda OumasoftLTD's ROE doesn't look that attractive. Although a closer study shows that the company's ROE is higher than the industry average of 4.9% which we definitely can't overlook. Still, Shandong Shanda OumasoftLTD's net income growth of 3.7% over the past five years was mediocre at best. Remember, the company's ROE is quite low to begin with, just that it is higher than the industry average. So that could be one of the factors that are causing earnings growth to stay low.

We then compared Shandong Shanda OumasoftLTD's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 9.5% in the same 5-year period, which is a bit concerning.

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

Is Shandong Shanda OumasoftLTD Using Its Retained Earnings Effectively?

While Shandong Shanda OumasoftLTD has a decent three-year median payout ratio of 32% (or a retention ratio of 68%), it has seen very little growth in earnings. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, Shandong Shanda OumasoftLTD started paying a dividend only recently. So it looks like the management must have perceived that shareholders favor dividends over earnings growth.

Conclusion

On the whole, we do feel that Shandong Shanda OumasoftLTD has some positive attributes. However, while the company does have a decent ROE and a high profit retention, its earnings growth number is quite disappointing. This suggests that there might be some external threat to the business, that's hampering 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. To know the 1 risk we have identified for Shandong Shanda OumasoftLTD 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.