With its stock down 5.9% over the past three months, it is easy to disregard Henan Dayou Energy (SHSE:600403). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Henan Dayou Energy's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Henan Dayou Energy

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 Henan Dayou Energy is:

7.5% = CN¥602m ÷ CN¥8.0b (Based on the trailing twelve months to September 2023).

The 'return' is the profit over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.08 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of Henan Dayou Energy's Earnings Growth And 7.5% ROE

At first glance, Henan Dayou Energy's ROE doesn't look very promising. Next, when compared to the average industry ROE of 12%, the company's ROE leaves us feeling even less enthusiastic. In spite of this, Henan Dayou Energy was able to grow its net income considerably, at a rate of 30% in the last five years. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Henan Dayou Energy'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 26% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Henan Dayou Energy's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Henan Dayou Energy Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 63% (implying that it keeps only 37% of profits) for Henan Dayou Energy suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.

Moreover, Henan Dayou Energy is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Conclusion

In total, it does look like Henan Dayou Energy has some positive aspects to its business. That is, quite an impressive growth in earnings. However, the low profit retention means that the company's earnings growth could have been higher, had it been reinvesting a higher portion of its profits. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. To gain further insights into Henan Dayou Energy'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.