It is hard to get excited after looking at Wuxi Best Precision Machinery's (SZSE:300580) recent performance, when its stock has declined 12% over the past month. However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Wuxi Best Precision Machinery'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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Do You Calculate Return On Equity?

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 Wuxi Best Precision Machinery is:

10% = CN¥288m ÷ CN¥2.8b (Based on the trailing twelve months to September 2023).

The 'return' is the profit over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.10 in profit.

Why Is ROE Important For 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.

A Side By Side comparison of Wuxi Best Precision Machinery's Earnings Growth And 10% ROE

At first glance, Wuxi Best Precision Machinery's ROE doesn't look very promising. However, the fact that the its ROE is quite higher to the industry average of 7.5% doesn't go unnoticed by us. This certainly adds some context to Wuxi Best Precision Machinery's moderate 11% net income growth seen over the past five years. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. Hence there might be some other aspects that are causing earnings to grow. For example, it is possible that the broader industry is going through a high growth phase, or that the company has a low payout ratio.

As a next step, we compared Wuxi Best Precision Machinery'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 3.9%.

Earnings growth is a huge factor in stock valuation. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. 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 Wuxi Best Precision Machinery is trading on a high P/E or a low P/E, relative to its industry.

Is Wuxi Best Precision Machinery Efficiently Re-investing Its Profits?

Wuxi Best Precision Machinery's three-year median payout ratio to shareholders is 24% (implying that it retains 76% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Additionally, Wuxi Best Precision Machinery has paid dividends over a period of seven years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 33% over the next three years. Regardless, the future ROE for Wuxi Best Precision Machinery is speculated to rise to 14% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.

Conclusion

On the whole, we feel that Wuxi Best Precision Machinery's performance has been quite good. In particular, it's great to see that the company has seen significant growth in its earnings backed by a respectable ROE and a high reinvestment rate. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.