Most readers would already be aware that MLOptic's (SHSE:688502) stock increased significantly by 17% over the past month. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. Specifically, we decided to study MLOptic's ROE in this article.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

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 MLOptic is:

2.9% = CN¥34m ÷ CN¥1.1b (Based on the trailing twelve months to June 2024).

The 'return' is the profit 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¥0.03 in profit.

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. 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. 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.

MLOptic's Earnings Growth And 2.9% ROE

It is hard to argue that MLOptic's ROE is much good in and of itself. Not just that, even compared to the industry average of 6.4%, the company's ROE is entirely unremarkable. Hence, the flat earnings seen by MLOptic over the past five years could probably be the result of it having a lower ROE.

As a next step, we compared MLOptic's net income growth with the industry and discovered that the industry saw an average growth of 4.8% in the same period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. What is 688502 worth today? The intrinsic value infographic in our free research report helps visualize whether 688502 is currently mispriced by the market.

Is MLOptic Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 59% (meaning, the company retains only 41% of profits) for MLOptic suggests that the company's earnings growth was miniscule as a result of paying out a majority of its earnings.

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

Conclusion

Overall, we would be extremely cautious before making any decision on MLOptic. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.