With its stock down 13% over the past three months, it is easy to disregard Hangzhou Honghua Digital Technology Stock (SHSE:688789). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Hangzhou Honghua Digital Technology Stock'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

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 Hangzhou Honghua Digital Technology Stock is:

12% = CN¥358m ÷ CN¥3.0b (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.12 in profit.

What Is The Relationship Between ROE And 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.

Hangzhou Honghua Digital Technology Stock's Earnings Growth And 12% ROE

To begin with, Hangzhou Honghua Digital Technology Stock seems to have a respectable ROE. Especially when compared to the industry average of 6.9% the company's ROE looks pretty impressive. Probably as a result of this, Hangzhou Honghua Digital Technology Stock was able to see a decent growth of 17% over the last five years.

Next, on comparing with the industry net income growth, we found that Hangzhou Honghua Digital Technology Stock's growth is quite high when compared to the industry average growth of 9.5% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. 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. 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 Hangzhou Honghua Digital Technology Stock is trading on a high P/E or a low P/E, relative to its industry.

Is Hangzhou Honghua Digital Technology Stock Making Efficient Use Of Its Profits?

Hangzhou Honghua Digital Technology Stock's three-year median payout ratio to shareholders is 18% (implying that it retains 82% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

While Hangzhou Honghua Digital Technology Stock has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend.

Conclusion

On the whole, we feel that Hangzhou Honghua Digital Technology Stock'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. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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