Most readers would already be aware that Southchip Semiconductor Technology(Shanghai)'s (SHSE:688484) stock increased significantly by 12% over the past three months. Since the market usually pay for a company's long-term fundamentals, we decided to study the company's key performance indicators to see if they could be influencing the market. In this article, we decided to focus on Southchip Semiconductor Technology(Shanghai)'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 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?

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 Southchip Semiconductor Technology(Shanghai) is:

9.1% = CN¥353m ÷ CN¥3.9b (Based on the trailing twelve months to September 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.

What Is The Relationship Between ROE And 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. 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.

Southchip Semiconductor Technology(Shanghai)'s Earnings Growth And 9.1% ROE

When you first look at it, Southchip Semiconductor Technology(Shanghai)'s ROE doesn't look that attractive. However, the fact that the company's ROE is higher than the average industry ROE of 6.0%, is definitely interesting. Even more so after seeing Southchip Semiconductor Technology(Shanghai)'s exceptional 36% net income growth over the past five years. That being said, the company does have a slightly low ROE to begin with, just that it is higher than the industry average. Hence, there might be some other aspects that are causing earnings to grow. E.g the company has a low payout ratio or could belong to a high growth industry.

As a next step, we compared Southchip Semiconductor Technology(Shanghai)'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 16%.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Southchip Semiconductor Technology(Shanghai) is trading on a high P/E or a low P/E, relative to its industry.

Is Southchip Semiconductor Technology(Shanghai) Using Its Retained Earnings Effectively?

Southchip Semiconductor Technology(Shanghai) has a three-year median payout ratio of 43% (where it is retaining 57% of its income) which is not too low or not too high. By the looks of it, the dividend is well covered and Southchip Semiconductor Technology(Shanghai) is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

While Southchip Semiconductor Technology(Shanghai) has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend.

Conclusion

In total, we are pretty happy with Southchip Semiconductor Technology(Shanghai)'s performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.