Hicon Network Technology (Shandong)Ltd's (SZSE:301262) stock is up by a considerable 23% 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 Hicon Network Technology (Shandong)Ltd's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

How Is ROE Calculated?

Return on equity can be calculated by using the formula:

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

So, based on the above formula, the ROE for Hicon Network Technology (Shandong)Ltd is:

12% = CN¥454m ÷ CN¥3.6b (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¥0.12.

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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

A Side By Side comparison of Hicon Network Technology (Shandong)Ltd's Earnings Growth And 12% ROE

To start with, Hicon Network Technology (Shandong)Ltd's ROE looks acceptable. Especially when compared to the industry average of 6.8% the company's ROE looks pretty impressive. Despite this, Hicon Network Technology (Shandong)Ltd's five year net income growth was quite low averaging at only 2.8%. That's a bit unexpected from a company which has such a high rate of return. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.

When you consider the fact that the industry earnings have shrunk at a rate of 16% in the same 5-year period, the company's net income growth is pretty remarkable.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Is Hicon Network Technology (Shandong)Ltd fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Hicon Network Technology (Shandong)Ltd Using Its Retained Earnings Effectively?

Hicon Network Technology (Shandong)Ltd has a three-year median payout ratio of 81% (implying that it keeps only 19% of its profits), meaning that it pays out most of its profits to shareholders as dividends, and as a result, the company has seen low earnings growth.

In addition, Hicon Network Technology (Shandong)Ltd only recently started paying a dividend so the management must have decided the shareholders prefer dividends over earnings growth.

Summary

Overall, we are quite pleased with Hicon Network Technology (Shandong)Ltd's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad.

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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.