Most readers would already be aware that Hubei Zhenhua ChemicalLtd's (SHSE:603067) stock increased significantly by 27% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Hubei Zhenhua ChemicalLtd's ROE in this article.

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 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 Hubei Zhenhua ChemicalLtd is:

12% = CN¥359m ÷ CN¥2.9b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.12.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

Hubei Zhenhua ChemicalLtd's Earnings Growth And 12% ROE

To begin with, Hubei Zhenhua ChemicalLtd seems to have a respectable ROE. On comparing with the average industry ROE of 6.3% the company's ROE looks pretty remarkable. This probably laid the ground for Hubei Zhenhua ChemicalLtd's significant 26% net income growth seen over the past 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.

Next, on comparing with the industry net income growth, we found that Hubei Zhenhua ChemicalLtd's growth is quite high when compared to the industry average growth of 7.9% 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. 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 Hubei Zhenhua ChemicalLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Hubei Zhenhua ChemicalLtd Making Efficient Use Of Its Profits?

Hubei Zhenhua ChemicalLtd's three-year median payout ratio to shareholders is 25%, which is quite low. This implies that the company is retaining 75% 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.

Additionally, Hubei Zhenhua ChemicalLtd has paid dividends over a period of seven years which means that the company is pretty serious about sharing its profits with shareholders.

Conclusion

On the whole, we feel that Hubei Zhenhua ChemicalLtd's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.

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