Henan Liliang Diamond (SZSE:301071) has had a great run on the share market with its stock up by a significant 48% over the last three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Henan Liliang Diamond's ROE.

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 Do You 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 Henan Liliang Diamond is:

5.2% = CN¥278m ÷ CN¥5.3b (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¥0.05 in profit.

Why Is ROE Important For 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Henan Liliang Diamond's Earnings Growth And 5.2% ROE

When you first look at it, Henan Liliang Diamond's ROE doesn't look that attractive. However, its ROE is similar to the industry average of 6.2%, so we won't completely dismiss the company. Particularly, the exceptional 25% net income growth seen by Henan Liliang Diamond over the past five years is pretty remarkable. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Henan Liliang Diamond's growth is quite high when compared to the industry average growth of 4.9% in the same period, which is great to see.

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. If you're wondering about Henan Liliang Diamond's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Henan Liliang Diamond Making Efficient Use Of Its Profits?

The three-year median payout ratio for Henan Liliang Diamond is 34%, which is moderately low. The company is retaining the remaining 66%. By the looks of it, the dividend is well covered and Henan Liliang Diamond is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Besides, Henan Liliang Diamond has been paying dividends over a period of three years. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 30%. Regardless, the future ROE for Henan Liliang Diamond is predicted to rise to 9.0% despite there being not much change expected in its payout ratio.

Summary

On the whole, we do feel that Henan Liliang Diamond has some positive attributes. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. 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.

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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.