Shanghai Shentong MetroLtd (SHSE:600834) has had a great run on the share market with its stock up by a significant 18% over the last week. 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. In this article, we decided to focus on Shanghai Shentong MetroLtd's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Shanghai Shentong MetroLtd

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 Shentong MetroLtd is:

4.7% = CN¥80m ÷ CN¥1.7b (Based on the trailing twelve months to September 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¥0.05 in profit.

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. 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.

Shanghai Shentong MetroLtd's Earnings Growth And 4.7% ROE

It is quite clear that Shanghai Shentong MetroLtd's ROE is rather low. A comparison with the industry shows that the company's ROE is pretty similar to the average industry ROE of 4.7%. As a result, Shanghai Shentong MetroLtd's decent 12% net income growth seen over the past five years bodes well with us. Given the low ROE, it is likely that there could be some other aspects that are driving this growth as well. For instance, the company has a low payout ratio or is being managed efficiently.

When you consider the fact that the industry earnings have shrunk at a rate of 6.9% in the same 5-year period, the company's net income growth is pretty remarkable.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. 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 Shanghai Shentong MetroLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Shanghai Shentong MetroLtd Using Its Retained Earnings Effectively?

Shanghai Shentong MetroLtd has a three-year median payout ratio of 30%, which implies that it retains the remaining 70% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Moreover, Shanghai Shentong MetroLtd is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Conclusion

Overall, we feel that Shanghai Shentong MetroLtd certainly does have some positive factors to consider. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business.

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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.