With its stock down 17% over the past three months, it is easy to disregard Western Metal Materials (SZSE:002149). However, stock prices are usually driven by a company's financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Western Metal Materials' ROE today.

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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Western Metal Materials is:

8.1% = CN¥283m ÷ CN¥3.5b (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.08 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

Western Metal Materials' Earnings Growth And 8.1% ROE

On the face of it, Western Metal Materials' ROE is not much to talk about. However, its ROE is similar to the industry average of 7.4%, so we won't completely dismiss the company. Particularly, the exceptional 28% net income growth seen by Western Metal Materials over the past five years is pretty remarkable. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's 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 Western Metal Materials' growth is quite high when compared to the industry average growth of 11% in the same period, which is great to see.

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. If you're wondering about Western Metal Materials''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Western Metal Materials Efficiently Re-investing Its Profits?

Western Metal Materials has a three-year median payout ratio of 48% (where it is retaining 52% of its income) which is not too low or not too high. So it seems that Western Metal Materials is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Moreover, Western Metal Materials is determined to keep sharing its profits with shareholders which we infer from its long history of six years of paying a dividend.

Conclusion

In total, it does look like Western Metal Materials has some positive aspects to its business. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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