Most readers would already be aware that Shenzhen WOTE Advanced MaterialsLtd's (SZSE:002886) stock increased significantly by 45% 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. Particularly, we will be paying attention to Shenzhen WOTE Advanced MaterialsLtd's ROE today.

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 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 Shenzhen WOTE Advanced MaterialsLtd is:

1.1% = CN¥21m ÷ CN¥1.8b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.01 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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.

Shenzhen WOTE Advanced MaterialsLtd's Earnings Growth And 1.1% ROE

It is hard to argue that Shenzhen WOTE Advanced MaterialsLtd's ROE is much good in and of itself. Even when compared to the industry average of 6.2%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 32% seen by Shenzhen WOTE Advanced MaterialsLtd over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

That being said, we compared Shenzhen WOTE Advanced MaterialsLtd's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 4.9% in the same 5-year period.

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. This then helps them determine if the stock is placed for a bright or bleak future. 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 Shenzhen WOTE Advanced MaterialsLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Shenzhen WOTE Advanced MaterialsLtd Making Efficient Use Of Its Profits?

Shenzhen WOTE Advanced MaterialsLtd's low three-year median payout ratio of 23% (implying that it retains the remaining 77% of its profits) comes as a surprise when you pair it with the shrinking earnings. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, Shenzhen WOTE Advanced MaterialsLtd has paid dividends over a period of seven years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Conclusion

On the whole, we feel that the performance shown by Shenzhen WOTE Advanced MaterialsLtd 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. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.