China Harzone Industry's (SZSE:300527) stock is up by a considerable 10% over the past 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. Particularly, we will be paying attention to China Harzone Industry's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for China Harzone Industry

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 China Harzone Industry is:

1.8% = CN¥51m ÷ CN¥2.9b (Based on the trailing twelve months to March 2023).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.02 in profit.

Why Is ROE Important For 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.

China Harzone Industry's Earnings Growth And 1.8% ROE

It is quite clear that China Harzone Industry's ROE is rather low. Even compared to the average industry ROE of 7.5%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 39% seen by China Harzone Industry was possibly a result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.

That being said, we compared China Harzone Industry's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 11% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. 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. Is China Harzone Industry fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is China Harzone Industry Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 27% (where it is retaining 73% of its profits), China Harzone Industry has seen a decline in earnings as we saw above. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, China Harzone Industry has paid dividends over a period of six years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Summary

In total, we're a bit ambivalent about China Harzone Industry's performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. Our risks dashboard would have the 3 risks we have identified for China Harzone Industry.

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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.