With its stock down 12% over the past month, it is easy to disregard Ningbo Huaxiang Electronic (SZSE:002048). 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 Ningbo Huaxiang Electronic's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Ningbo Huaxiang Electronic is:

10% = CN¥1.3b ÷ CN¥13b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.10.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Ningbo Huaxiang Electronic's Earnings Growth And 10% ROE

On the face of it, Ningbo Huaxiang Electronic's ROE is not much to talk about. However, the fact that the company's ROE is higher than the average industry ROE of 8.2%, is definitely interesting. However, Ningbo Huaxiang Electronic has seen a flattish net income growth over the past five years, which is not saying much. Remember, the company's ROE is a bit low to begin with, just that it is higher than the industry average. Therefore, the low to flat growth in earnings could also be the result of this.

Next, on comparing with the industry net income growth, we found that Ningbo Huaxiang Electronic's reported growth was lower than the industry growth of 9.1% over the last few years, which is not something we like to see.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. 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 Ningbo Huaxiang Electronic is trading on a high P/E or a low P/E, relative to its industry.

Is Ningbo Huaxiang Electronic Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 49% (implying that the company keeps 51% of its income) over the last three years, Ningbo Huaxiang Electronic has seen a negligible amount of growth in earnings as we saw above. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, Ningbo Huaxiang Electronic has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 46% of its profits over the next three years. Accordingly, forecasts suggest that Ningbo Huaxiang Electronic's future ROE will be 11% which is again, similar to the current ROE.

Conclusion

On the whole, we do feel that Ningbo Huaxiang Electronic has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a moderate ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.