It is hard to get excited after looking at Hicon Network Technology (Shandong)Ltd's (SZSE:301262) recent performance, when its stock has declined 19% over the past three months. 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 Hicon Network Technology (Shandong)Ltd's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

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 Hicon Network Technology (Shandong)Ltd is:

12% = CN¥412m ÷ CN¥3.5b (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¥0.12 in profit.

Why Is ROE Important For Earnings Growth?

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

A Side By Side comparison of Hicon Network Technology (Shandong)Ltd's Earnings Growth And 12% ROE

To begin with, Hicon Network Technology (Shandong)Ltd seems to have a respectable ROE. On comparing with the average industry ROE of 6.4% the company's ROE looks pretty remarkable. Despite this, Hicon Network Technology (Shandong)Ltd's five year net income growth was quite flat over the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

As a next step, we compared Hicon Network Technology (Shandong)Ltd's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 1.9% in the same period.

Earnings growth is a huge factor in stock valuation. 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. 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 Hicon Network Technology (Shandong)Ltd is trading on a high P/E or a low P/E, relative to its industry.

Is Hicon Network Technology (Shandong)Ltd Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 92% (implying that the company keeps only 8.2% of its income) of its business to reinvest into its business), most of Hicon Network Technology (Shandong)Ltd's profits are being paid to shareholders, which explains the absence of growth in earnings.

Additionally, Hicon Network Technology (Shandong)Ltd started paying a dividend only recently. So it looks like the management must have perceived that shareholders favor dividends over earnings growth.

Summary

In total, it does look like Hicon Network Technology (Shandong)Ltd has some positive aspects to its business. Its earnings have grown respectably as we saw earlier, probably due to its high returns. However, it does reinvest little to almost none of its profits, so we wonder what effect this could have on its future growth prospects. Up till now, we've only made a short study of the company's growth data. So it may be worth checking this free detailed graph of Hicon Network Technology (Shandong)Ltd's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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.