Most readers would already be aware that Shanghai Huafon Aluminium's (SHSE:601702) stock increased significantly by 17% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on Shanghai Huafon Aluminium's ROE.

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?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Shanghai Huafon Aluminium is:

19% = CN¥813m ÷ CN¥4.3b (Based on the trailing twelve months to September 2023).

The 'return' refers to a company's earnings over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.19.

Why Is ROE Important For 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 Shanghai Huafon Aluminium's Earnings Growth And 19% ROE

At first glance, Shanghai Huafon Aluminium seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 7.5%. Probably as a result of this, Shanghai Huafon Aluminium was able to see an impressive net income growth of 38% over the last five years. We believe that there might also 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.

As a next step, we compared Shanghai Huafon Aluminium'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 12%.

Earnings growth is an important metric to consider when valuing a stock. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Shanghai Huafon Aluminium fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Shanghai Huafon Aluminium Making Efficient Use Of Its Profits?

Shanghai Huafon Aluminium's ' three-year median payout ratio is on the lower side at 13% implying that it is retaining a higher percentage (87%) of its profits. So it looks like Shanghai Huafon Aluminium is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Besides, Shanghai Huafon Aluminium has been paying dividends over a period of three years. This shows that the company is committed to sharing profits with its shareholders.

Conclusion

In total, we are pretty happy with Shanghai Huafon Aluminium's performance. 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.

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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.