Shanghai Action Education TechnologyLTD (SHSE:605098) has had a great run on the share market with its stock up by a significant 23% 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. Particularly, we will be paying attention to Shanghai Action Education TechnologyLTD's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

How Is ROE Calculated?

ROE 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 Action Education TechnologyLTD is:

23% = CN¥228m ÷ CN¥989m (Based on the trailing twelve months to March 2024).

The 'return' is the profit over the last twelve months. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.23.

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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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 Action Education TechnologyLTD's Earnings Growth And 23% ROE

Firstly, we acknowledge that Shanghai Action Education TechnologyLTD has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 7.5% which is quite remarkable. Probably as a result of this, Shanghai Action Education TechnologyLTD was able to see a decent net income growth of 13% over the last five years.

When you consider the fact that the industry earnings have shrunk at a rate of 4.3% in the same 5-year period, the company's net income growth is pretty remarkable.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Is Shanghai Action Education TechnologyLTD fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Shanghai Action Education TechnologyLTD Using Its Retained Earnings Effectively?

While Shanghai Action Education TechnologyLTD has a three-year median payout ratio of 98% (which means it retains 1.9% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.

Additionally, Shanghai Action Education TechnologyLTD has paid dividends over a period of three years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 64% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 34%, over the same period.

Summary

On the whole, we do feel that Shanghai Action Education TechnologyLTD has some positive attributes. Namely, its high earnings growth, which was likely due to its high ROE. However, investors could have benefitted even more from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining hardly any of its profits. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.