Most readers would already know that Ningbo Huaxiang Electronic's (SZSE:002048) stock increased by 9.6% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to investigate if the company's decent financials had a hand to play in the recent price move. In this article, we decided to focus on Ningbo Huaxiang Electronic'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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

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 Ningbo Huaxiang Electronic is:

8.1% = CN¥1.1b ÷ CN¥14b (Based on the trailing twelve months to December 2023).

The 'return' refers to a company's earnings over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.08 in profit.

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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company's earnings growth potential. 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.

Ningbo Huaxiang Electronic's Earnings Growth And 8.1% ROE

At first glance, Ningbo Huaxiang Electronic's ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 7.6%, we may spare it some thought. Even so, Ningbo Huaxiang Electronic has shown a fairly decent growth in its net income which grew at a rate of 6.7%. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Ningbo Huaxiang Electronic'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 5.0%.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. 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 Ningbo Huaxiang Electronic is trading on a high P/E or a low P/E, relative to its industry.

Is Ningbo Huaxiang Electronic Making Efficient Use Of Its Profits?

With a three-year median payout ratio of 29% (implying that the company retains 71% of its profits), it seems that Ningbo Huaxiang Electronic is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Moreover, Ningbo Huaxiang Electronic 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 28%. Regardless, the future ROE for Ningbo Huaxiang Electronic is predicted to rise to 11% despite there being not much change expected in its payout ratio.

Conclusion

On the whole, we do feel that Ningbo Huaxiang Electronic has some positive attributes. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. 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.