With its stock down 11% over the past month, it is easy to disregard Hubei W-olf Photoelectric Technology (SZSE:002962). To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. Specifically, we decided to study Hubei W-olf Photoelectric Technology's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. 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?

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 Hubei W-olf Photoelectric Technology is:

3.9% = CN¥71m ÷ CN¥1.8b (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.04 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

Hubei W-olf Photoelectric Technology's Earnings Growth And 3.9% ROE

It is quite clear that Hubei W-olf Photoelectric Technology's ROE is rather low. Even when compared to the industry average of 6.2%, the ROE figure is pretty disappointing. Therefore, it might not be wrong to say that the five year net income decline of 17% seen by Hubei W-olf Photoelectric Technology was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

So, as a next step, we compared Hubei W-olf Photoelectric Technology's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 9.0% over the last few years.

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. If you're wondering about Hubei W-olf Photoelectric Technology's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Hubei W-olf Photoelectric Technology Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 67% (implying that 33% of the profits are retained), most of Hubei W-olf Photoelectric Technology's profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. To know the 4 risks we have identified for Hubei W-olf Photoelectric Technology visit our risks dashboard for free.

Additionally, Hubei W-olf Photoelectric Technology has paid dividends over a period of four years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Summary

Overall, we would be extremely cautious before making any decision on Hubei W-olf Photoelectric Technology. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. Up till now, we've only made a short study of the company's growth data. So it may be worth checking this free detailed graph of Hubei W-olf Photoelectric Technology's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com