With its stock down 2.9% over the past week, it is easy to disregard Lumina Group (HKG:1162). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Lumina Group's 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Lumina Group

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 Lumina Group is:

18% = HK$23m ÷ HK$129m (Based on the trailing twelve months to December 2019).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every HK$1 worth of equity, the company was able to earn HK$0.18 in profit.

Why Is ROE Important For Earnings Growth?

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

A Side By Side comparison of Lumina Group's Earnings Growth And 18% ROE

To start with, Lumina Group's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 12%. This certainly adds some context to Lumina Group's decent 15% net income growth seen over the past five years.

As a next step, we compared Lumina Group's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 12%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Lumina Group is trading on a high P/E or a low P/E, relative to its industry.

Is Lumina Group Efficiently Re-investing Its Profits?

Lumina Group doesn't pay any dividend, meaning that all of its profits are being reinvested in the business, which explains the fair bit of earnings growth the company has seen.

Conclusion

In total, we are pretty happy with Lumina Group's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings.

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. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company.

You can see the 1 risk we have identified for Lumina Group by visiting our risks dashboard for free on our platform here.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.