With its stock down 24% over the past month, it is easy to disregard Shenzhen Zhongheng Huafa (SZSE:000020). However, stock prices are usually driven by a company's financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Shenzhen Zhongheng Huafa's ROE in this article.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How To 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 Shenzhen Zhongheng Huafa is:

3.8% = CN¥14m ÷ CN¥366m (Based on the trailing twelve months to September 2023).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.04 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

Shenzhen Zhongheng Huafa's Earnings Growth And 3.8% ROE

As you can see, Shenzhen Zhongheng Huafa's ROE looks pretty weak. Not just that, even compared to the industry average of 6.3%, the company's ROE is entirely unremarkable. However, we we're pleasantly surprised to see that Shenzhen Zhongheng Huafa grew its net income at a significant rate of 24% in the last five years. Therefore, there could be other reasons behind this growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Shenzhen Zhongheng Huafa'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 8.8%.

Earnings growth is an important metric to consider when valuing a stock. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Shenzhen Zhongheng Huafa is trading on a high P/E or a low P/E, relative to its industry.

Is Shenzhen Zhongheng Huafa Efficiently Re-investing Its Profits?

Shenzhen Zhongheng Huafa doesn't pay any regular dividends currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the high earnings growth number that we discussed above.

Conclusion

In total, it does look like Shenzhen Zhongheng Huafa 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. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 2 risks we have identified for Shenzhen Zhongheng Huafa visit our risks dashboard for free.

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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.