With its stock down 21% over the past three months, it is easy to disregard Guangdong Hongtu Technology (holdings)Ltd (SZSE:002101). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on Guangdong Hongtu Technology (holdings)Ltd's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

How Do You 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 Guangdong Hongtu Technology (holdings)Ltd is:

5.5% = CN¥423m ÷ CN¥7.7b (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.05 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. 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.

A Side By Side comparison of Guangdong Hongtu Technology (holdings)Ltd's Earnings Growth And 5.5% ROE

When you first look at it, Guangdong Hongtu Technology (holdings)Ltd's ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 7.5% either. However, we we're pleasantly surprised to see that Guangdong Hongtu Technology (holdings)Ltd grew its net income at a significant rate of 23% in the last five years. Therefore, there could be other reasons behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Guangdong Hongtu Technology (holdings)Ltd'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 11%.

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 Guangdong Hongtu Technology (holdings)Ltd is trading on a high P/E or a low P/E, relative to its industry.

Is Guangdong Hongtu Technology (holdings)Ltd Using Its Retained Earnings Effectively?

While the company did pay out a portion of its dividend in the past, it currently doesn't pay a dividend. This is likely what's driving the high earnings growth number discussed above.

Conclusion

In total, it does look like Guangdong Hongtu Technology (holdings)Ltd has some positive aspects to its business. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. 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.