Shenzhen Lifotronic Technology (SHSE:688389) has had a rough three months with its share price down 16%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Shenzhen Lifotronic Technology'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 Do You 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 Lifotronic Technology is:

19% = CN¥379m ÷ CN¥1.9b (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¥0.19 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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 Lifotronic Technology's Earnings Growth And 19% ROE

At first glance, Shenzhen Lifotronic Technology seems to have a decent ROE. Especially when compared to the industry average of 7.1% the company's ROE looks pretty impressive. This certainly adds some context to Shenzhen Lifotronic Technology's exceptional 27% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Shenzhen Lifotronic Technology's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 6.1%.

Earnings growth is an important metric to consider when valuing a stock. 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. 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 Lifotronic Technology is trading on a high P/E or a low P/E, relative to its industry.

Is Shenzhen Lifotronic Technology Making Efficient Use Of Its Profits?

The three-year median payout ratio for Shenzhen Lifotronic Technology is 36%, which is moderately low. The company is retaining the remaining 64%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Shenzhen Lifotronic Technology is reinvesting its earnings efficiently.

Besides, Shenzhen Lifotronic Technology has been paying dividends over a period of five years. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 36%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 21%.

Summary

In total, we are pretty happy with Shenzhen Lifotronic Technology's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.