It is hard to get excited after looking at Guoquan Food (Shanghai)'s (HKG:2517) recent performance, when its stock has declined 40% over the past three months. However, stock prices are usually driven by a company's financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Guoquan Food (Shanghai)'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 Is ROE Calculated?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Guoquan Food (Shanghai) is:

7.2% = CN¥232m ÷ CN¥3.2b (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each HK$1 of shareholders' capital it has, the company made HK$0.07 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

Guoquan Food (Shanghai)'s Earnings Growth And 7.2% ROE

On the face of it, Guoquan Food (Shanghai)'s ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.2%. Particularly, the exceptional 59% net income growth seen by Guoquan Food (Shanghai) over the past five years is pretty remarkable. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Guoquan Food (Shanghai)'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 18%.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is Guoquan Food (Shanghai) fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Guoquan Food (Shanghai) Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 58% (implying that it keeps only 42% of profits) for Guoquan Food (Shanghai) suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.

Conclusion

Overall, we feel that Guoquan Food (Shanghai) certainly does have some positive factors to consider. While no doubt its earnings growth is pretty substantial, we do feel that the reinvestment rate is pretty low, meaning, the earnings growth number could have been significantly higher had the company been retaining more of its profits. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. To gain further insights into Guoquan Food (Shanghai)'s past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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.