Most readers would already be aware that Shenzhen Sunlord ElectronicsLtd's (SZSE:002138) stock increased significantly by 16% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on Shenzhen Sunlord ElectronicsLtd's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. 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?

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 Shenzhen Sunlord ElectronicsLtd is:

13% = CN¥836m ÷ CN¥6.5b (Based on the trailing twelve months to March 2024).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.13 in profit.

Why Is ROE Important For 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.

A Side By Side comparison of Shenzhen Sunlord ElectronicsLtd's Earnings Growth And 13% ROE

To begin with, Shenzhen Sunlord ElectronicsLtd seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 6.3%. However, for some reason, the higher returns aren't reflected in Shenzhen Sunlord ElectronicsLtd's meagre five year net income growth average of 5.0%. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn't been able to do so. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or poor allocation of capital.

We then compared Shenzhen Sunlord ElectronicsLtd's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 6.4% in the same 5-year period, which is a bit concerning.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Shenzhen Sunlord ElectronicsLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Shenzhen Sunlord ElectronicsLtd Efficiently Re-investing Its Profits?

Despite having a normal three-year median payout ratio of 32% (or a retention ratio of 68% over the past three years, Shenzhen Sunlord ElectronicsLtd has seen very little growth in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, Shenzhen Sunlord ElectronicsLtd has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 31%. However, Shenzhen Sunlord ElectronicsLtd's ROE is predicted to rise to 16% despite there being no anticipated change in its payout ratio.

Conclusion

On the whole, we do feel that Shenzhen Sunlord ElectronicsLtd has some positive attributes. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.

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