RLX Technology Inc.'s (NYSE:RLX) Stock's On An Uptrend: Are Strong Financials Guiding The Market?

RLX Technology (NYSE:RLX) has had a great run on the share market with its stock up by a significant 70% over the last three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on RLX Technology's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Our analysis indicates that RLX is potentially undervalued!

How Do You 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 RLX Technology is:

14% = CN¥2.1b ÷ CN¥16b (Based on the trailing twelve months to September 2022).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.14 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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

RLX Technology's Earnings Growth And 14% ROE

To begin with, RLX Technology seems to have a respectable ROE. Yet, the fact that the company's ROE is lower than the industry average of 18% does temper our expectations. However, we are pleased to see the impressive 78% net income growth reported by RLX Technology over the past five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this also does lend some color to the high earnings growth seen by the company.

We then compared RLX Technology'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 13% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. 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 RLX Technology is trading on a high P/E or a low P/E, relative to its industry.

Is RLX Technology Efficiently Re-investing Its Profits?

Given that RLX Technology doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.

Summary

In total, we are pretty happy with RLX Technology's performance. Specifically, we like that it has been reinvesting a high portion of its profits at a moderate rate of return, resulting in earnings expansion. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.