Sanhe Tongfei Refrigeration (SZSE:300990) has had a great run on the share market with its stock up by a significant 5.8% over the last week. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Sanhe Tongfei Refrigeration's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Sanhe Tongfei Refrigeration

How To Calculate Return On Equity?

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 Sanhe Tongfei Refrigeration is:

11% = CN¥183m ÷ CN¥1.7b (Based on the trailing twelve months to September 2023).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.11 in profit.

What Has ROE Got To Do With 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.

Sanhe Tongfei Refrigeration's Earnings Growth And 11% ROE

At first glance, Sanhe Tongfei Refrigeration's ROE doesn't look very promising. However, the fact that the its ROE is quite higher to the industry average of 7.5% doesn't go unnoticed by us. Consequently, this likely laid the ground for the decent growth of 12% seen over the past five years by Sanhe Tongfei Refrigeration. 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.

As a next step, we compared Sanhe Tongfei Refrigeration's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 11% in the same period.

Earnings growth is a huge factor in stock valuation. 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. 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 Sanhe Tongfei Refrigeration is trading on a high P/E or a low P/E, relative to its industry.

Is Sanhe Tongfei Refrigeration Making Efficient Use Of Its Profits?

While Sanhe Tongfei Refrigeration has a three-year median payout ratio of 51% (which means it retains 49% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.

While Sanhe Tongfei Refrigeration has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend.

Summary

In total, it does look like Sanhe Tongfei Refrigeration has some positive aspects to its business. Namely, its significant earnings growth, to which its moderate rate of return likely contributed. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.