Shenzhen FRD Science & Technology (SZSE:300602) has had a great run on the share market with its stock up by a significant 26% over the last three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. In this article, we decided to focus on Shenzhen FRD Science & Technology's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. 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 Shenzhen FRD Science & Technology is:

3.3% = CN¥130m ÷ CN¥3.9b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.03.

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. 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. 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.

Shenzhen FRD Science & Technology's Earnings Growth And 3.3% ROE

It is quite clear that Shenzhen FRD Science & Technology's ROE is rather low. Even compared to the average industry ROE of 6.4%, the company's ROE is quite dismal. For this reason, Shenzhen FRD Science & Technology's five year net income decline of 27% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

However, when we compared Shenzhen FRD Science & Technology's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 10% in the same period. This is quite worrisome.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Shenzhen FRD Science & Technology fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Shenzhen FRD Science & Technology Using Its Retained Earnings Effectively?

Shenzhen FRD Science & Technology's low three-year median payout ratio of 12% (or a retention ratio of 88%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. This typically shouldn't be the case when a company is retaining most of its earnings. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.

In addition, Shenzhen FRD Science & Technology has been paying dividends over a period of eight years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 17% over the next three years. Regardless, the future ROE for Shenzhen FRD Science & Technology is speculated to rise to 9.0% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.

Summary

In total, we're a bit ambivalent about Shenzhen FRD Science & Technology's performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. 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.