Huarong Chemical's (SZSE:301256) stock is up by a considerable 49% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Huarong Chemical's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How To 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 Huarong Chemical is:

5.8% = CN¥98m ÷ CN¥1.7b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.06 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. 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.

A Side By Side comparison of Huarong Chemical's Earnings Growth And 5.8% ROE

When you first look at it, Huarong Chemical's ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 6.2%, we may spare it some thought. Having said that, Huarong Chemical has shown a modest net income growth of 6.0% over the past five years. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. Such as - high earnings retention or an efficient management in place.

We then compared Huarong Chemical'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 4.9% in the same 5-year period.

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). This then helps them determine if the stock is placed for a bright or bleak future. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Huarong Chemical is trading on a high P/E or a low P/E, relative to its industry.

Is Huarong Chemical Efficiently Re-investing Its Profits?

Huarong Chemical's three-year median payout ratio to shareholders is 25% (implying that it retains 75% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Moreover, Huarong Chemical is determined to keep sharing its profits with shareholders which we infer from its long history of three years of paying a dividend.

Conclusion

In total, it does look like Huarong Chemical has some positive aspects to its business. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 3 risks we have identified for Huarong Chemical by visiting our risks dashboard for free on our platform here.

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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.