Most readers would already know that Hengtong Optic-Electric's (SHSE:600487) stock increased by 9.8% over the past three months. As most would know, long-term fundamentals have a strong correlation with market price movements, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study Hengtong Optic-Electric'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Hengtong Optic-Electric is:

8.3% = CN¥2.4b ÷ CN¥29b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn 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 Hengtong Optic-Electric's Earnings Growth And 8.3% ROE

On the face of it, Hengtong Optic-Electric's ROE is not much to talk about. Although a closer study shows that the company's ROE is higher than the industry average of 6.2% which we definitely can't overlook. This probably goes some way in explaining Hengtong Optic-Electric's moderate 5.1% growth over the past five years amongst other factors. That being said, the company does have a slightly low ROE to begin with, just that it is higher than the industry average. So there might well be other reasons for the earnings to grow. E.g the company has a low payout ratio or could belong to a high growth industry.

As a next step, we compared Hengtong Optic-Electric's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 15% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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. If you're wondering about Hengtong Optic-Electric's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Hengtong Optic-Electric Efficiently Re-investing Its Profits?

In Hengtong Optic-Electric's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 11% (or a retention ratio of 89%), which suggests that the company is investing most of its profits to grow its business.

Moreover, Hengtong Optic-Electric 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. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 15% over the next three years. Still, forecasts suggest that Hengtong Optic-Electric's future ROE will rise to 11% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.

Summary

In total, it does look like Hengtong Optic-Electric has some positive aspects to its business. In particular, it's great to see that the company is investing heavily into its business and along with a moderate rate of return, that has resulted in a respectable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.