Hongli Zhihui GroupLtd (SZSE:300219) has had a rough week with its share price down 9.2%. However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Hongli Zhihui GroupLtd's ROE.

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.

See our latest analysis for Hongli Zhihui GroupLtd

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 Hongli Zhihui GroupLtd is:

8.8% = CN¥225m ÷ CN¥2.6b (Based on the trailing twelve months to September 2023).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.09 in profit.

What Is The Relationship Between ROE And Earnings Growth?

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

Hongli Zhihui GroupLtd's Earnings Growth And 8.8% ROE

When you first look at it, Hongli Zhihui GroupLtd's ROE doesn't look that attractive. However, the fact that the company's ROE is higher than the average industry ROE of 6.4%, is definitely interesting. Especially when you consider Hongli Zhihui GroupLtd's exceptional 36% net income growth over the past five years. That being said, the company does have a slightly low ROE to begin with, just that it is higher than the industry average. Therefore, the growth in earnings could also be the result of other factors. E.g the company has a low payout ratio or could belong to a high growth industry.

We then compared Hongli Zhihui GroupLtd's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 28% in the same 5-year period.

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 Hongli Zhihui GroupLtd fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Hongli Zhihui GroupLtd Using Its Retained Earnings Effectively?

Hongli Zhihui GroupLtd doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the high earnings growth number that we discussed above.

Conclusion

In total, we are pretty happy with Hongli Zhihui GroupLtd's performance. In particular, it's great to see that the company has seen significant growth in its earnings backed by a respectable ROE and a high reinvestment rate.

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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.