Guizhou Chanhen Chemical's (SZSE:002895) stock is up by a considerable 16% over the past month. Since the market usually pay for a company's long-term fundamentals, we decided to study the company's key performance indicators to see if they could be influencing the market. Specifically, we decided to study Guizhou Chanhen Chemical's ROE in this article.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

How Do You 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 Guizhou Chanhen Chemical is:

14% = CN¥858m ÷ CN¥6.1b (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.14.

Why Is ROE Important For 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 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.

Guizhou Chanhen Chemical's Earnings Growth And 14% ROE

To start with, Guizhou Chanhen Chemical's ROE looks acceptable. Especially when compared to the industry average of 6.4% the company's ROE looks pretty impressive. Probably as a result of this, Guizhou Chanhen Chemical was able to see an impressive net income growth of 38% over the last five years. However, there could also be other causes behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared Guizhou Chanhen Chemical's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 6.3% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is 002895 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Guizhou Chanhen Chemical Using Its Retained Earnings Effectively?

Guizhou Chanhen Chemical's three-year median payout ratio is a pretty moderate 45%, meaning the company retains 55% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Guizhou Chanhen Chemical is reinvesting its earnings efficiently.

Moreover, Guizhou Chanhen Chemical is determined to keep sharing its profits with shareholders which we infer from its long history of six years of paying a dividend. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 58% over the next three years. However, Guizhou Chanhen Chemical's future ROE is expected to rise to 19% 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.

Conclusion

In total, we are pretty happy with Guizhou Chanhen Chemical's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.