It is hard to get excited after looking at Henan Senyuan Electric's (SZSE:002358) recent performance, when its stock has declined 16% over the past month. However, stock prices are usually driven by a company's financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Henan Senyuan Electric's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

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 Henan Senyuan Electric is:

3.6% = CN¥117m ÷ CN¥3.3b (Based on the trailing twelve months to September 2024).

The 'return' is the profit 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.

Henan Senyuan Electric's Earnings Growth And 3.6% ROE

As you can see, Henan Senyuan Electric's ROE looks pretty weak. Even when compared to the industry average of 6.4%, the ROE figure is pretty disappointing. In spite of this, Henan Senyuan Electric was able to grow its net income considerably, at a rate of 31% in the last five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. 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.

Next, on comparing with the industry net income growth, we found that Henan Senyuan Electric's growth is quite high when compared to the industry average growth of 10% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. 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. 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 Henan Senyuan Electric is trading on a high P/E or a low P/E, relative to its industry.

Is Henan Senyuan Electric Using Its Retained Earnings Effectively?

Henan Senyuan Electric's ' three-year median payout ratio is on the lower side at 19% implying that it is retaining a higher percentage (81%) of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Besides, Henan Senyuan Electric has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.

Conclusion

Overall, we feel that Henan Senyuan Electric certainly does have some positive factors to consider. 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. 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. To know the 1 risk we have identified for Henan Senyuan Electric visit our risks dashboard for free.

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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.