Wafer Works (Shanghai) (SHSE:688584) has had a rough month with its share price down 17%. To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. Specifically, we decided to study Wafer Works (Shanghai)'s ROE in this article.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

How To Calculate Return On Equity?

Return on equity 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 Wafer Works (Shanghai) is:

2.7% = CN¥112m ÷ CN¥4.1b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.03 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

A Side By Side comparison of Wafer Works (Shanghai)'s Earnings Growth And 2.7% ROE

As you can see, Wafer Works (Shanghai)'s ROE looks pretty weak. Not just that, even compared to the industry average of 6.4%, the company's ROE is entirely unremarkable. However, the moderate 10% net income growth seen by Wafer Works (Shanghai) over the past five years is definitely a positive. We reckon that there could be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that Wafer Works (Shanghai)'s reported growth was lower than the industry growth of 14% over the last few years, which is not something we like to see.

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. Doing so will help them establish if the stock's future looks promising or ominous. Is Wafer Works (Shanghai) fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Wafer Works (Shanghai) Making Efficient Use Of Its Profits?

Wafer Works (Shanghai) has a significant three-year median payout ratio of 99%, meaning that it is left with only 1.0% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Conclusion

On the whole, Wafer Works (Shanghai)'s performance is quite a big let-down. Although the company has shown a fair bit of growth in earnings, yet the low ROE and the low rate of reinvestment makes us skeptical about the continuity of that growth, especially when or if the business comes to face any threats. So far, we've only made a quick discussion around the company's earnings growth. To gain further insights into Wafer Works (Shanghai)'s past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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.