With its stock down 20% over the past three months, it is easy to disregard Hexing ElectricalLtd (SHSE:603556). However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Hexing ElectricalLtd's 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. 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 Hexing ElectricalLtd is:

16% = CN¥1.1b ÷ CN¥6.9b (Based on the trailing twelve months to September 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¥0.16 in profit.

Why Is ROE Important For 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 Hexing ElectricalLtd's Earnings Growth And 16% ROE

To start with, Hexing ElectricalLtd's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 6.3%. Probably as a result of this, Hexing ElectricalLtd was able to see an impressive net income growth of 22% over the last five years. We reckon that there could also be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Hexing ElectricalLtd'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 3.9%.

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. This then helps them determine if the stock is placed for a bright or bleak future. Is 603556 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Hexing ElectricalLtd Making Efficient Use Of Its Profits?

Hexing ElectricalLtd's three-year median payout ratio is a pretty moderate 48%, meaning the company retains 52% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Hexing ElectricalLtd is reinvesting its earnings efficiently.

Additionally, Hexing ElectricalLtd has paid dividends over a period of seven years which means that the company is pretty serious about sharing its profits with shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 53%. Still, forecasts suggest that Hexing ElectricalLtd's future ROE will rise to 19% even though the the company's payout ratio is not expected to change by much.

Summary

On the whole, we feel that Hexing ElectricalLtd'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. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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