Longyan Kaolin Clay's (SHSE:605086) stock is up by a considerable 50% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Longyan Kaolin Clay's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How To Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Longyan Kaolin Clay is:

9.8% = CN¥120m ÷ CN¥1.2b (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¥0.10 in profit.

Why Is ROE Important For 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. 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.

Longyan Kaolin Clay's Earnings Growth And 9.8% ROE

When you first look at it, Longyan Kaolin Clay's ROE doesn't look that attractive. However, the fact that the its ROE is quite higher to the industry average of 5.7% doesn't go unnoticed by us. This certainly adds some context to Longyan Kaolin Clay's moderate 9.5% net income growth seen over the past five years. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. So there might well be other reasons for the earnings to grow. For example, it is possible that the broader industry is going through a high growth phase, or that the company has a low payout ratio.

Next, on comparing with the industry net income growth, we found that the growth figure reported by Longyan Kaolin Clay compares quite favourably to the industry average, which shows a decline of 7.3% over the last few years.

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. This then helps them determine if the stock is placed for a bright or bleak future. Is Longyan Kaolin Clay fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Longyan Kaolin Clay Making Efficient Use Of Its Profits?

Longyan Kaolin Clay has a three-year median payout ratio of 42%, which implies that it retains the remaining 58% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Additionally, Longyan Kaolin Clay has paid dividends over a period of three years which means that the company is pretty serious about sharing its profits with shareholders.

Conclusion

Overall, we are quite pleased with Longyan Kaolin Clay's performance. Specifically, we like that it has been reinvesting a high portion of its profits at a moderate rate of return, resulting in earnings expansion.

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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.