It is hard to get excited after looking at Power HF's (SHSE:605100) recent performance, when its stock has declined 17% over the past week. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. In this article, we decided to focus on Power HF's ROE.

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 Is ROE Calculated?

ROE 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 Power HF is:

5.6% = CN¥102m ÷ CN¥1.8b (Based on the trailing twelve months to September 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¥0.06.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Power HF's Earnings Growth And 5.6% ROE

On the face of it, Power HF's ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 6.3%. But Power HF saw a five year net income decline of 22% over the past five years. Remember, the company's ROE is a bit low to begin with. Hence, this goes some way in explaining the shrinking earnings.

That being said, we compared Power HF's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 7.4% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Power HF is trading on a high P/E or a low P/E, relative to its industry.

Is Power HF Efficiently Re-investing Its Profits?

Power HF's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 63% (or a retention ratio of 38%). With only very little left to reinvest into the business, growth in earnings is far from likely. Our risks dashboard should have the 2 risks we have identified for Power HF.

Additionally, Power HF has paid dividends over a period of four years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Conclusion

On the whole, Power HF's performance is quite a big let-down. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. So far, we've only made a quick discussion around the company's earnings growth. You can do your own research on Power HF 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.