It is hard to get excited after looking at Hunan Aihua Group's (SHSE:603989) recent performance, when its stock has declined 18% over the past three months. However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Hunan Aihua Group's ROE in this article.

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.

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 Hunan Aihua Group is:

12% = CN¥426m ÷ CN¥3.6b (Based on the trailing twelve months to September 2023).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.12 in profit.

What Has ROE Got To Do With 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.

Hunan Aihua Group's Earnings Growth And 12% ROE

To begin with, Hunan Aihua Group seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 6.3%. This probably laid the ground for Hunan Aihua Group's moderate 9.5% net income growth seen over the past five years.

Next, on comparing Hunan Aihua Group's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 8.8% over the last few years.

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). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Hunan Aihua Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Hunan Aihua Group Efficiently Re-investing Its Profits?

With a three-year median payout ratio of 28% (implying that the company retains 72% of its profits), it seems that Hunan Aihua Group is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Additionally, Hunan Aihua Group has paid dividends over a period of nine years which means that the company is pretty serious about sharing its profits with shareholders.

Conclusion

Overall, we are quite pleased with Hunan Aihua 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. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.