Huaming Power EquipmentLtd (SZSE:002270) has had a rough month with its share price down 18%. 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 Huaming Power EquipmentLtd's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How Do You Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Huaming Power EquipmentLtd is:

16% = CN¥559m ÷ CN¥3.5b (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.16.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

Huaming Power EquipmentLtd's Earnings Growth And 16% ROE

To begin with, Huaming Power EquipmentLtd seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 6.8%. Probably as a result of this, Huaming Power EquipmentLtd was able to see an impressive net income growth of 21% over the last five years. We reckon that there could also be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared Huaming Power EquipmentLtd's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 9.5% in the same 5-year 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. Is Huaming Power EquipmentLtd fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Huaming Power EquipmentLtd Efficiently Re-investing Its Profits?

The really high three-year median payout ratio of 103% for Huaming Power EquipmentLtd suggests that the company is paying its shareholders more than what it is earning. However, this hasn't hampered its ability to grow as we saw earlier. Although, it could be worth keeping an eye on the high payout ratio as that's a huge risk.

Additionally, Huaming Power EquipmentLtd has paid dividends over a period of eight years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 76% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 24%, over the same period.

Conclusion

Overall, we feel that Huaming Power EquipmentLtd certainly does have some positive factors to consider. Specifically, its high ROE which likely led to the growth in earnings. Bear in mind, the company reinvests little to none of its profits, which means that investors aren't necessarily reaping the full benefits of the high rate of return. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com