It is hard to get excited after looking at SG Micro's (SZSE:300661) recent performance, when its stock has declined 23% over the past three months. However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study SG Micro's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company's success at turning shareholder investments into profits.

How Do You Calculate Return On Equity?

ROE can be calculated by using the formula:

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

So, based on the above formula, the ROE for SG Micro is:

8.7% = CN¥357m ÷ CN¥4.1b (Based on the trailing twelve months to June 2024).

The 'return' is the profit 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¥0.09.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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 SG Micro's Earnings Growth And 8.7% ROE

On the face of it, SG Micro's ROE is not much to talk about. Although a closer study shows that the company's ROE is higher than the industry average of 5.9% which we definitely can't overlook. Consequently, this likely laid the ground for the decent growth of 16% seen over the past five years by SG Micro. That being said, the company does have a slightly low ROE to begin with, just that it is higher than the industry average. So there might well be other reasons for the earnings to grow. For example, it is possible that the broader industry is going through a high growth phase, or that the company has a low payout ratio.

We then performed a comparison between SG Micro's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 17% in the same 5-year period.

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). Doing so will help them establish if the stock's future looks promising or ominous. Is SG Micro fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is SG Micro Efficiently Re-investing Its Profits?

SG Micro has a low three-year median payout ratio of 15%, meaning that the company retains the remaining 85% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Additionally, SG Micro has paid dividends over a period of six years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 25% over the next three years. Still, forecasts suggest that SG Micro's future ROE will rise to 17% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.

Conclusion

On the whole, we feel that SG Micro's performance has been quite good. In particular, it's great to see that the company has seen significant growth in its earnings backed by a respectable ROE and a high reinvestment rate. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.