Xiangyu MedicalLtd (SHSE:688626) has had a rough three months with its share price down 30%. However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Xiangyu MedicalLtd's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

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 Xiangyu MedicalLtd is:

11% = CN¥228m ÷ CN¥2.1b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax 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¥0.11.

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. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

Xiangyu MedicalLtd's Earnings Growth And 11% ROE

To start with, Xiangyu MedicalLtd's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 7.4%. Despite this, Xiangyu MedicalLtd's five year net income growth was quite low averaging at only 4.4%. That's a bit unexpected from a company which has such a high rate of return. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

As a next step, we compared Xiangyu MedicalLtd's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 5.4% in the same period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Xiangyu MedicalLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Xiangyu MedicalLtd Efficiently Re-investing Its Profits?

Despite having a normal three-year median payout ratio of 28% (or a retention ratio of 72% over the past three years, Xiangyu MedicalLtd has seen very little growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, Xiangyu MedicalLtd has paid dividends over a period of three years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Conclusion

Overall, we are quite pleased with Xiangyu MedicalLtd's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see a good amount of growth in its earnings. 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.