Shanghai Friendess Electronic Technology (SHSE:688188) has had a rough week with its share price down 7.7%. However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Shanghai Friendess Electronic Technology's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. 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?

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 Shanghai Friendess Electronic Technology is:

15% = CN¥819m ÷ CN¥5.3b (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.15.

What Has ROE Got To Do With 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Shanghai Friendess Electronic Technology's Earnings Growth And 15% ROE

To start with, Shanghai Friendess Electronic Technology's ROE looks acceptable. Especially when compared to the industry average of 6.3% the company's ROE looks pretty impressive. Probably as a result of this, Shanghai Friendess Electronic Technology was able to see an impressive net income growth of 25% over the last five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that Shanghai Friendess Electronic Technology's growth is quite high when compared to the industry average growth of 6.4% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is Shanghai Friendess Electronic Technology fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Shanghai Friendess Electronic Technology Efficiently Re-investing Its Profits?

The three-year median payout ratio for Shanghai Friendess Electronic Technology is 34%, which is moderately low. The company is retaining the remaining 66%. By the looks of it, the dividend is well covered and Shanghai Friendess Electronic Technology is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Additionally, Shanghai Friendess Electronic Technology has paid dividends over a period of four 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 over the next three years is expected to be approximately 39%. However, Shanghai Friendess Electronic Technology's ROE is predicted to rise to 21% despite there being no anticipated change in its payout ratio.

Conclusion

On the whole, we feel that Shanghai Friendess Electronic Technology's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.