It is hard to get excited after looking at Shandong Hualu-Hengsheng Chemical's (SHSE:600426) recent performance, when its stock has declined 6.6% over the past week. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Shandong Hualu-Hengsheng Chemical's ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Is ROE Calculated?

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 Shandong Hualu-Hengsheng Chemical is:

12% = CN¥4.0b ÷ CN¥33b (Based on the trailing twelve months to September 2024).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.12.

What Has ROE Got To Do With Earnings Growth?

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

A Side By Side comparison of Shandong Hualu-Hengsheng Chemical's Earnings Growth And 12% ROE

To begin with, Shandong Hualu-Hengsheng Chemical seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 6.2%. This probably laid the ground for Shandong Hualu-Hengsheng Chemical's moderate 10% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that Shandong Hualu-Hengsheng Chemical's growth is quite high when compared to the industry average growth of 4.9% in the same period, which is great to see.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Shandong Hualu-Hengsheng Chemical fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Shandong Hualu-Hengsheng Chemical Efficiently Re-investing Its Profits?

Shandong Hualu-Hengsheng Chemical has a healthy combination of a moderate three-year median payout ratio of 33% (or a retention ratio of 67%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Besides, Shandong Hualu-Hengsheng Chemical has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 30% of its profits over the next three years. As a result, Shandong Hualu-Hengsheng Chemical's ROE is not expected to change by much either, which we inferred from the analyst estimate of 14% for future ROE.

Conclusion

Overall, we are quite pleased with Shandong Hualu-Hengsheng Chemical's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.