It is hard to get excited after looking at Luzhou LaojiaoLtd's (SZSE:000568) recent performance, when its stock has declined 34% over the past three months. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Luzhou LaojiaoLtd's ROE.

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 Do You 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 Luzhou LaojiaoLtd is:

34% = CN¥14b ÷ CN¥42b (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.34 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Luzhou LaojiaoLtd's Earnings Growth And 34% ROE

Firstly, we acknowledge that Luzhou LaojiaoLtd has a significantly high ROE. Secondly, even when compared to the industry average of 17% the company's ROE is quite impressive. Under the circumstances, Luzhou LaojiaoLtd's considerable five year net income growth of 25% was to be expected.

As a next step, we compared Luzhou LaojiaoLtd's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 15%.

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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Luzhou LaojiaoLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Luzhou LaojiaoLtd Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 55% (implying that it keeps only 45% of profits) for Luzhou LaojiaoLtd suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.

Additionally, Luzhou LaojiaoLtd has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. 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 59%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 31%.

Summary

In total, we are pretty happy with Luzhou LaojiaoLtd's performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.