Focus Hotmelt (SZSE:301283) has had a great run on the share market with its stock up by a significant 31% over the last week. Since the market usually pay for a company's long-term fundamentals, we decided to study the company's key performance indicators to see if they could be influencing the market. Specifically, we decided to study Focus Hotmelt'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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

How To Calculate Return On Equity?

ROE 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 Focus Hotmelt is:

8.1% = CN¥123m ÷ CN¥1.5b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.08 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Focus Hotmelt's Earnings Growth And 8.1% ROE

At first glance, Focus Hotmelt's ROE doesn't look very promising. However, the fact that the its ROE is quite higher to the industry average of 6.4% doesn't go unnoticed by us. This probably goes some way in explaining Focus Hotmelt's moderate 11% growth over the past five years amongst other factors. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. Hence there might be some other aspects that are causing earnings to grow. E.g the company has a low payout ratio or could belong to a high growth industry.

As a next step, we compared Focus Hotmelt'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 6.2%.

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. 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 Focus Hotmelt's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Focus Hotmelt Efficiently Re-investing Its Profits?

Focus Hotmelt has a three-year median payout ratio of 42%, which implies that it retains the remaining 58% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

While Focus Hotmelt has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend.

Conclusion

On the whole, we feel that Focus Hotmelt's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.