Are Strong Financial Prospects The Force That Is Driving The Momentum In Shanghai Shuixing Home Textile Co., Ltd.'s SHSE:603365) Stock?

Shanghai Shuixing Home Textile's (SHSE:603365) stock is up by a considerable 66% 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. Particularly, we will be paying attention to Shanghai Shuixing Home Textile's ROE today.

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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Shanghai Shuixing Home Textile

How Is ROE Calculated?

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 Shanghai Shuixing Home Textile is:

12% = CN¥337m ÷ CN¥2.9b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.12.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Shanghai Shuixing Home Textile's Earnings Growth And 12% ROE

At first glance, Shanghai Shuixing Home Textile seems to have a decent ROE. On comparing with the average industry ROE of 7.1% the company's ROE looks pretty remarkable. Despite this, Shanghai Shuixing Home Textile's five year net income growth was quite low averaging at only 3.9%. That's a bit unexpected from a company which has such a high rate of return. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or poor allocation of capital.

Next, on comparing with the industry net income growth, we found that Shanghai Shuixing Home Textile's growth is quite high when compared to the industry average growth of 2.8% in the same period, which is great to see.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Shanghai Shuixing Home Textile is trading on a high P/E or a low P/E, relative to its industry.

Is Shanghai Shuixing Home Textile Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 54% (that is, the company retains only 46% of its income) over the past three years for Shanghai Shuixing Home Textile suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.

Moreover, Shanghai Shuixing Home Textile has been paying dividends for seven years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

In total, we are pretty happy with Shanghai Shuixing Home Textile's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.