Most readers would already be aware that Hengtong Optic-Electric's (SHSE:600487) stock increased significantly by 12% over the past month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on Hengtong Optic-Electric's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How To Calculate Return On Equity?

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 Hengtong Optic-Electric is:

8.9% = CN¥2.7b ÷ CN¥30b (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.09 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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.

Hengtong Optic-Electric's Earnings Growth And 8.9% ROE

On the face of it, Hengtong Optic-Electric's ROE is not much to talk about. However, the fact that the company's ROE is higher than the average industry ROE of 7.4%, is definitely interesting. This probably goes some way in explaining Hengtong Optic-Electric's moderate 11% growth over the past five years amongst other factors. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. Hence there might be some other aspects that are causing earnings to grow. E.g the company has a low payout ratio or could belong to a high growth industry.

As a next step, we compared Hengtong Optic-Electric'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 12% in the same period.

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 Hengtong Optic-Electric's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Hengtong Optic-Electric Efficiently Re-investing Its Profits?

Hengtong Optic-Electric has a low three-year median payout ratio of 11%, meaning that the company retains the remaining 89% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Additionally, Hengtong Optic-Electric has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 16% over the next three years. However, Hengtong Optic-Electric's future ROE is expected to rise to 12% despite the expected increase in the company's payout ratio. We infer that there could be other factors that could be driving the anticipated growth in the company's ROE.

Summary

Overall, we are quite pleased with Hengtong Optic-Electric's performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.