Wuhan Lincontrol Automotive Electronics (SHSE:688667) has had a great run on the share market with its stock up by a significant 25% over the last three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on Wuhan Lincontrol Automotive Electronics' ROE.

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.

View our latest analysis for Wuhan Lincontrol Automotive Electronics

How To 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 Wuhan Lincontrol Automotive Electronics is:

3.5% = CN¥55m ÷ CN¥1.6b (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.04 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

Wuhan Lincontrol Automotive Electronics' Earnings Growth And 3.5% ROE

As you can see, Wuhan Lincontrol Automotive Electronics' ROE looks pretty weak. Even when compared to the industry average of 7.4%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 6.3% seen by Wuhan Lincontrol Automotive Electronics over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.

So, as a next step, we compared Wuhan Lincontrol Automotive Electronics' performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 3.8% over the last few years.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Wuhan Lincontrol Automotive Electronics''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Wuhan Lincontrol Automotive Electronics Using Its Retained Earnings Effectively?

Wuhan Lincontrol Automotive Electronics' low three-year median payout ratio of 15% (implying that it retains the remaining 85% of its profits) comes as a surprise when you pair it with the shrinking earnings. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Only recently, Wuhan Lincontrol Automotive Electronics stated paying a dividend. This likely means that the management might have concluded that its shareholders have a strong preference for dividends.

Conclusion

In total, we're a bit ambivalent about Wuhan Lincontrol Automotive Electronics' performance. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.