It is hard to get excited after looking at Hangcha Group's (SHSE:603298) recent performance, when its stock has declined 11% over the past three months. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Hangcha Group's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Hangcha Group is:

20% = CN¥1.9b ÷ CN¥9.6b (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned 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¥0.20 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. 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 Hangcha Group's Earnings Growth And 20% ROE

To start with, Hangcha Group's ROE looks acceptable. Especially when compared to the industry average of 6.9% the company's ROE looks pretty impressive. Probably as a result of this, Hangcha Group was able to see an impressive net income growth of 21% over the last five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

We then compared Hangcha Group'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 9.5% in the same 5-year period.

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. Is 603298 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Hangcha Group Efficiently Re-investing Its Profits?

Hangcha Group has a three-year median payout ratio of 36% (where it is retaining 64% of its income) which is not too low or not too high. By the looks of it, the dividend is well covered and Hangcha Group is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Moreover, Hangcha Group is determined to keep sharing its profits with shareholders which we infer from its long history of seven years of paying a dividend. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 35% of its profits over the next three years. Accordingly, forecasts suggest that Hangcha Group's future ROE will be 21% which is again, similar to the current ROE.

Conclusion

On the whole, we feel that Hangcha Group's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com