It is hard to get excited after looking at Hangzhou Hikvision Digital Technology's (SZSE:002415) recent performance, when its stock has declined 24% over the past three months. However, stock prices are usually driven by a company's financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Hangzhou Hikvision Digital Technology's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How To Calculate Return On Equity?

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 Hangzhou Hikvision Digital Technology is:

19% = CN¥15b ÷ CN¥80b (Based on the trailing twelve months to June 2024).

The 'return' is the profit 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¥0.19 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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 Hangzhou Hikvision Digital Technology's Earnings Growth And 19% ROE

At first glance, Hangzhou Hikvision Digital Technology seems to have a decent ROE. Especially when compared to the industry average of 6.4% the company's ROE looks pretty impressive. Despite this, Hangzhou Hikvision Digital Technology's five year net income growth was quite low averaging at only 2.5%. That's a bit unexpected from a company which has such a high rate of return. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

As a next step, we compared Hangzhou Hikvision Digital Technology's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 5.0% in the same period.

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. This then helps them determine if the stock is placed for a bright or bleak future. What is 002415 worth today? The intrinsic value infographic in our free research report helps visualize whether 002415 is currently mispriced by the market.

Is Hangzhou Hikvision Digital Technology Making Efficient Use Of Its Profits?

Hangzhou Hikvision Digital Technology has a three-year median payout ratio of 52% (implying that it keeps only 48% of its profits), meaning that it pays out most of its profits to shareholders as dividends, and as a result, the company has seen low earnings growth.

In addition, Hangzhou Hikvision Digital Technology has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 54%. As a result, Hangzhou Hikvision Digital Technology's ROE is not expected to change by much either, which we inferred from the analyst estimate of 20% for future ROE.

Conclusion

In total, it does look like Hangzhou Hikvision Digital Technology has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.