Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou (SZSE:000523) has had a rough month with its share price down 14%. 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. Specifically, we decided to study Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou's ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How To Calculate Return On Equity?

ROE 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 Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou is:

7.3% = CN¥116m ÷ CN¥1.6b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.07 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou's Earnings Growth And 7.3% ROE

When you first look at it, Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou's ROE doesn't look that attractive. However, the fact that the its ROE is quite higher to the industry average of 6.0% doesn't go unnoticed by us. This certainly adds some context to Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou's moderate 20% net income growth seen 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. Hence there might be some other aspects that are causing earnings to grow. For example, it is possible that the broader industry is going through a high growth phase, or that the company has a low payout ratio.

Given that the industry shrunk its earnings at a rate of 3.1% over the last few years, the net income growth of the company is quite impressive.

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). This then helps them determine if the stock is placed for a bright or bleak future. 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 Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou is trading on a high P/E or a low P/E, relative to its industry.

Is Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou Making Efficient Use Of Its Profits?

Given that Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou doesn't pay any regular dividends to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.

Conclusion

Overall, we are quite pleased with Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou'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. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. Our risks dashboard will have the 1 risk we have identified for Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou.

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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.