With its stock down 17% over the past month, it is easy to disregard Zhuzhou Hongda ElectronicsLtd (SZSE:300726). 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 Zhuzhou Hongda ElectronicsLtd's ROE.

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 return on equity is:

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

So, based on the above formula, the ROE for Zhuzhou Hongda ElectronicsLtd is:

8.9% = CN¥459m ÷ CN¥5.1b (Based on the trailing twelve months to March 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¥0.09.

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. 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. 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.

Zhuzhou Hongda ElectronicsLtd's Earnings Growth And 8.9% ROE

At first glance, Zhuzhou Hongda ElectronicsLtd's ROE doesn't look very promising. Although a closer study shows that the company's ROE is higher than the industry average of 6.3% which we definitely can't overlook. Consequently, this likely laid the ground for the decent growth of 17% seen over the past five years by Zhuzhou Hongda ElectronicsLtd. 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. E.g the company has a low payout ratio or could belong to a high growth industry.

As a next step, we compared Zhuzhou Hongda ElectronicsLtd'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 6.4%.

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. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for 300726? You can find out in our latest intrinsic value infographic research report

Is Zhuzhou Hongda ElectronicsLtd Using Its Retained Earnings Effectively?

With a three-year median payout ratio of 28% (implying that the company retains 72% of its profits), it seems that Zhuzhou Hongda ElectronicsLtd is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Additionally, Zhuzhou Hongda ElectronicsLtd has paid dividends over a period of six years which means that the company is pretty serious about sharing its profits with shareholders.

Summary

On the whole, we feel that Zhuzhou Hongda ElectronicsLtd's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com