Most readers would already be aware that Hengsheng Energy's (SHSE:605580) stock increased significantly by 30% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Specifically, we decided to study Hengsheng Energy'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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Hengsheng Energy is:

15% = CN¥148m ÷ CN¥963m (Based on the trailing twelve months to September 2024).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.15 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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

Hengsheng Energy's Earnings Growth And 15% ROE

To start with, Hengsheng Energy's ROE looks acceptable. On comparing with the average industry ROE of 7.9% the company's ROE looks pretty remarkable. Probably as a result of this, Hengsheng Energy was able to see a decent growth of 7.8% over the last five years.

As a next step, we compared Hengsheng Energy'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 19% in the same period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Hengsheng Energy's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Hengsheng Energy Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 73% (or a retention ratio of 27%) for Hengsheng Energy suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Moreover, Hengsheng Energy is determined to keep sharing its profits with shareholders which we infer from its long history of three years of paying a dividend.

Summary

Overall, we feel that Hengsheng Energy certainly does have some positive factors to consider. Its earnings growth is decent, and the high ROE does contribute to that growth. However, investors could have benefitted even more from the high ROE, had the company been reinvesting more of its earnings. Up till now, we've only made a short study of the company's growth data. You can do your own research on Hengsheng Energy and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.

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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.