Shanghai Information2 Software Inc.'s (SHSE:688435) Stock Is Going Strong: Have Financials A Role To Play?

Shanghai Information2 Software's (SHSE:688435) stock is up by a considerable 54% over the past month. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Specifically, we decided to study Shanghai Information2 Software's ROE in this article.

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

See our latest analysis for Shanghai Information2 Software

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Shanghai Information2 Software is:

2.1% = CN¥23m ÷ CN¥1.1b (Based on the trailing twelve months to June 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¥0.02 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

Shanghai Information2 Software's Earnings Growth And 2.1% ROE

It is quite clear that Shanghai Information2 Software's ROE is rather low. Not just that, even compared to the industry average of 4.5%, the company's ROE is entirely unremarkable. Shanghai Information2 Software was still able to see a decent net income growth of 7.8% over the past five years. Therefore, the growth in earnings could probably have been caused by other variables. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared Shanghai Information2 Software'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 0.8% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is Shanghai Information2 Software fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Shanghai Information2 Software Making Efficient Use Of Its Profits?

Shanghai Information2 Software doesn't pay any regular dividends, meaning that all of its profits are being reinvested in the business, which explains the fair bit of earnings growth the company has seen.

Summary

In total, it does look like Shanghai Information2 Software has some positive aspects to its business. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 3 risks we have identified for Shanghai Information2 Software visit our risks dashboard for free.

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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.