Most readers would already be aware that Shanghai Tongji Science&Technology IndustrialLtd's (SHSE:600846) stock increased significantly by 11% over the past week. 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. Specifically, we decided to study Shanghai Tongji Science&Technology IndustrialLtd's ROE in this article.

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 To 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 Shanghai Tongji Science&Technology IndustrialLtd is:

10% = CN¥395m ÷ CN¥4.0b (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¥0.10 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. 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.

A Side By Side comparison of Shanghai Tongji Science&Technology IndustrialLtd's Earnings Growth And 10% ROE

On the face of it, Shanghai Tongji Science&Technology IndustrialLtd's ROE is not much to talk about. However, the fact that the its ROE is quite higher to the industry average of 7.3% doesn't go unnoticed by us. However, Shanghai Tongji Science&Technology IndustrialLtd's five year net income decline rate was 5.9%. Remember, the company's ROE is a bit low to begin with, just that it is higher than the industry average. So that could be one of the factors that are causing earnings growth to shrink.

However, when we compared Shanghai Tongji Science&Technology IndustrialLtd's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 7.8% in the same period. This is quite worrisome.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Shanghai Tongji Science&Technology IndustrialLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Shanghai Tongji Science&Technology IndustrialLtd Efficiently Re-investing Its Profits?

Despite having a normal three-year median payout ratio of 33% (where it is retaining 67% of its profits), Shanghai Tongji Science&Technology IndustrialLtd has seen a decline in earnings as we saw above. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Additionally, Shanghai Tongji Science&Technology IndustrialLtd 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.

Summary

Overall, we feel that Shanghai Tongji Science&Technology IndustrialLtd certainly does have some positive factors to consider. However, while the company does have a decent ROE and a high profit retention, its earnings growth number is quite disappointing. This suggests that there might be some external threat to the business, that's hampering growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 3 risks we have identified for Shanghai Tongji Science&Technology IndustrialLtd by visiting our risks dashboard for free on our platform here.

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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