Shunfa Hengye (SZSE:000631) has had a great run on the share market with its stock up by a significant 16% over the last three months. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. In this article, we decided to focus on Shunfa Hengye'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Shunfa Hengye

How Do You Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for Shunfa Hengye is:

5.4% = CN¥320m ÷ CN¥5.9b (Based on the trailing twelve months to September 2023).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.05.

Why Is ROE Important For 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. 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.

Shunfa Hengye's Earnings Growth And 5.4% ROE

On the face of it, Shunfa Hengye's ROE is not much to talk about. However, given that the company's ROE is similar to the average industry ROE of 5.5%, we may spare it some thought. But then again, Shunfa Hengye's five year net income shrunk at a rate of 45%. Bear in mind, the company does have a slightly low ROE. Therefore, the decline in earnings could also be the result of this.

Next, when we compared with the industry, which has shrunk its earnings at a rate of 4.2% in the same 5-year period, we still found Shunfa Hengye's performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Shunfa Hengye's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shunfa Hengye Making Efficient Use Of Its Profits?

Shunfa Hengye's high three-year median payout ratio of 378% suggests that the company is depleting its resources to keep up its dividend payments, and this shows in its shrinking earnings. Paying a dividend beyond their means is usually not viable over the long term. You can see the 5 risks we have identified for Shunfa Hengye by visiting our risks dashboard for free on our platform here.

Moreover, Shunfa Hengye 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.

Summary

On the whole, Shunfa Hengye's performance is quite a big let-down. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. Up till now, we've only made a short study of the company's growth data. To gain further insights into Shunfa Hengye's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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.