With its stock down 14% over the past three months, it is easy to disregard Hebei Hengshui Laobaigan Liquor (SHSE:600559). However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Hebei Hengshui Laobaigan Liquor'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

How Is ROE Calculated?

Return on equity 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 Hebei Hengshui Laobaigan Liquor is:

14% = CN¥700m ÷ CN¥5.0b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.14 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.

Hebei Hengshui Laobaigan Liquor's Earnings Growth And 14% ROE

At first glance, Hebei Hengshui Laobaigan Liquor seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 16%. This certainly adds some context to Hebei Hengshui Laobaigan Liquor's moderate 16% net income growth seen over the past five years.

Next, on comparing Hebei Hengshui Laobaigan Liquor's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 15% over the last few years.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Has the market priced in the future outlook for 600559? You can find out in our latest intrinsic value infographic research report.

Is Hebei Hengshui Laobaigan Liquor Using Its Retained Earnings Effectively?

Hebei Hengshui Laobaigan Liquor has a three-year median payout ratio of 42%, which implies that it retains the remaining 58% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Moreover, Hebei Hengshui Laobaigan Liquor 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 67% over the next three years. Regardless, the future ROE for Hebei Hengshui Laobaigan Liquor is speculated to rise to 20% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.

Conclusion

In total, we are pretty happy with Hebei Hengshui Laobaigan Liquor's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.

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