With its stock down 17% over the past month, it is easy to disregard Shenzhen SNC Opto ElectronicLtd (SZSE:001326). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Shenzhen SNC Opto ElectronicLtd's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Is ROE Calculated?

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 SNC Opto ElectronicLtd is:

9.4% = CN¥114m ÷ CN¥1.2b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.09 in profit.

What Is The Relationship Between ROE And 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. 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.

A Side By Side comparison of Shenzhen SNC Opto ElectronicLtd's Earnings Growth And 9.4% ROE

On the face of it, Shenzhen SNC Opto ElectronicLtd's ROE is not much to talk about. However, the fact that the its ROE is quite higher to the industry average of 6.4% doesn't go unnoticed by us. Especially when you consider Shenzhen SNC Opto ElectronicLtd's exceptional 20% net income growth over the past five years. That being said, the company does have a slightly low ROE to begin with, just that it is higher than the industry average. Hence, there might be some other aspects that are causing earnings to grow. Such as- high earnings retention or the company belonging to a high growth industry.

We then compared Shenzhen SNC Opto ElectronicLtd's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 10% in the same 5-year period.

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. 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 SNC Opto ElectronicLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Shenzhen SNC Opto ElectronicLtd Using Its Retained Earnings Effectively?

Shenzhen SNC Opto ElectronicLtd's three-year median payout ratio is a pretty moderate 46%, meaning the company retains 54% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Shenzhen SNC Opto ElectronicLtd is reinvesting its earnings efficiently.

While Shenzhen SNC Opto ElectronicLtd has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend.

Conclusion

In total, we are pretty happy with Shenzhen SNC Opto ElectronicLtd's performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. Our risks dashboard would have the 3 risks we have identified for Shenzhen SNC Opto ElectronicLtd.

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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.