Most readers would already be aware that Hangzhou Tianyuan Pet Products' (SZSE:301335) stock increased significantly by 51% over the past three months. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. Particularly, we will be paying attention to Hangzhou Tianyuan Pet Products' ROE today.

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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

How Do You 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 Hangzhou Tianyuan Pet Products is:

4.1% = CN¥76m ÷ CN¥1.9b (Based on the trailing twelve months to September 2024).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.04 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

Hangzhou Tianyuan Pet Products' Earnings Growth And 4.1% ROE

It is hard to argue that Hangzhou Tianyuan Pet Products' ROE is much good in and of itself. An industry comparison shows that the company's ROE is not much different from the industry average of 4.1% either. Given the low ROE Hangzhou Tianyuan Pet Products' five year net income decline of 5.5% is not surprising.

Next, when we compared with the industry, which has shrunk its earnings at a rate of 1.9% in the same 5-year period, we still found Hangzhou Tianyuan Pet Products' performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Hangzhou Tianyuan Pet Products fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Hangzhou Tianyuan Pet Products Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 54% (implying that 46% of the profits are retained), most of Hangzhou Tianyuan Pet Products' profits are being paid to shareholders, which explains the company's shrinking earnings. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. You can see the 2 risks we have identified for Hangzhou Tianyuan Pet Products by visiting our risks dashboard for free on our platform here.

In addition, Hangzhou Tianyuan Pet Products only recently started paying a dividend so the management probably decided the shareholders prefer dividends even though earnings have been shrinking.

Summary

In total, we would have a hard think before deciding on any investment action concerning Hangzhou Tianyuan Pet Products. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.