It is hard to get excited after looking at Hunan Aihua Group's (SHSE:603989) recent performance, when its stock has declined 20% over the past three months. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Hunan Aihua Group'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

How Is ROE Calculated?

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 Hunan Aihua Group is:

7.7% = CN¥283m ÷ CN¥3.7b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made 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. 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.

Hunan Aihua Group's Earnings Growth And 7.7% ROE

On the face of it, Hunan Aihua Group's ROE is not much to talk about. However, the fact that the company's ROE is higher than the average industry ROE of 6.3%, is definitely interesting. However, Hunan Aihua Group's five year net income growth was quite low averaging at only 4.6%. Bear in mind, the company does have a low ROE. It is just that the industry ROE is lower. Hence, this goes some way in explaining the low earnings growth.

We then compared Hunan Aihua Group's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 6.4% in the same 5-year period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Hunan Aihua Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Hunan Aihua Group Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 28% (or a retention ratio of 72% over the past three years, Hunan Aihua Group has seen very little growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Moreover, Hunan Aihua Group has been paying dividends for nine years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

Overall, we feel that Hunan Aihua Group certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a moderate ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.