It is hard to get excited after looking at Shunfa Hengneng's (SZSE:000631) recent performance, when its stock has declined 23% over the past three months. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. Particularly, we will be paying attention to Shunfa Hengneng's ROE today.

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?

ROE 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 Shunfa Hengneng is:

5.6% = CN¥333m ÷ CN¥6.0b (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.06 in profit.

What Has ROE Got To Do With 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 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.

Shunfa Hengneng's Earnings Growth And 5.6% ROE

At first glance, Shunfa Hengneng's ROE doesn't look very promising. However, the fact that the company's ROE is higher than the average industry ROE of 3.8%, is definitely interesting. However, Shunfa Hengneng's five year net income decline rate was 32%. Bear in mind, the company does have a slightly low ROE. It is just that the industry ROE is lower. Therefore, the decline in earnings could also be the result of this.

Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate of 12% over the last few years, we found that Shunfa Hengneng's performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Shunfa Hengneng's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shunfa Hengneng Using Its Retained Earnings Effectively?

Shunfa Hengneng's very high three-year median payout ratio of 296% over the last three years suggests that the company is paying its shareholders more than what it is earning and this explains the company's shrinking earnings. Its usually very hard to sustain dividend payments that are higher than reported profits. Our risks dashboard should have the 5 risks we have identified for Shunfa Hengneng.

Additionally, Shunfa Hengneng has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Shunfa Hengneng. While its ROE is pretty moderate, the company is retaining very little of its profits, meaning very little of its profits are being reinvested into the business. This explains the lack or absence of growth in its earnings. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. So it may be worth checking this free detailed graph of Shunfa Hengneng's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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.