Most readers would already be aware that Shanghai Jahwa United's (SHSE:600315) stock increased significantly by 11% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on Shanghai Jahwa United'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 Is ROE Calculated?

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 Shanghai Jahwa United is:

3.5% = CN¥269m ÷ CN¥7.7b (Based on the trailing twelve months to September 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¥0.03 in profit.

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 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.

A Side By Side comparison of Shanghai Jahwa United's Earnings Growth And 3.5% ROE

As you can see, Shanghai Jahwa United's ROE looks pretty weak. Even when compared to the industry average of 9.9%, the ROE figure is pretty disappointing. Therefore, Shanghai Jahwa United's flat earnings over the past five years can possibly be explained by the low ROE amongst other factors.

As a next step, we compared Shanghai Jahwa United's net income growth with the industry and discovered that the industry saw an average growth of 7.9% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Shanghai Jahwa United is trading on a high P/E or a low P/E, relative to its industry.

Is Shanghai Jahwa United Efficiently Re-investing Its Profits?

In spite of a normal three-year median payout ratio of 30% (or a retention ratio of 70%), Shanghai Jahwa United hasn't seen much growth in its earnings. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, Shanghai Jahwa United has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. 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 35%. Regardless, the future ROE for Shanghai Jahwa United is predicted to rise to 6.2% despite there being not much change expected in its payout ratio.

Conclusion

On the whole, we feel that the performance shown by Shanghai Jahwa United can be open to many interpretations. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.