It is hard to get excited after looking at Jiangxi Sunshine Dairy's (SZSE:001318) recent performance, when its stock has declined 13% over the past week. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. In this article, we decided to focus on Jiangxi Sunshine Dairy'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 ROE is:

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

So, based on the above formula, the ROE for Jiangxi Sunshine Dairy is:

7.9% = CN¥107m ÷ CN¥1.4b (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.08 in profit.

Why Is ROE Important For 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. 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.

A Side By Side comparison of Jiangxi Sunshine Dairy's Earnings Growth And 7.9% ROE

When you first look at it, Jiangxi Sunshine Dairy's ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 8.1%, we may spare it some thought. However, Jiangxi Sunshine Dairy has seen a flattish net income growth over the past five years, which is not saying much. Bear in mind, the company's ROE is not very high. Hence, this provides some context to the flat earnings growth seen by the company.

Next, on comparing with the industry net income growth, we found that Jiangxi Sunshine Dairy's reported growth was lower than the industry growth of 1.3% over the last few years, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. 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 Jiangxi Sunshine Dairy's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Jiangxi Sunshine Dairy Using Its Retained Earnings Effectively?

Despite having a moderate three-year median payout ratio of 38% (meaning the company retains62% of profits) in the last three-year period, Jiangxi Sunshine Dairy's earnings growth was more or les flat. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, Jiangxi Sunshine Dairy started paying a dividend only recently. So it looks like the management must have perceived that shareholders favor dividends over earnings growth.

Conclusion

On the whole, we feel that the performance shown by Jiangxi Sunshine Dairy can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Up till now, we've only made a short study of the company's growth data. You can do your own research on Jiangxi Sunshine Dairy and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.

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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.