Could The Market Be Wrong About Changhong Huayi Compressor Co., Ltd. (SZSE:000404) Given Its Attractive Financial Prospects?

It is hard to get excited after looking at Changhong Huayi Compressor's (SZSE:000404) recent performance, when its stock has declined 9.0% over the past week. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Changhong Huayi Compressor's ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Changhong Huayi Compressor

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 Changhong Huayi Compressor is:

12% = CN¥648m ÷ CN¥5.3b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.12 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. 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. 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.

Changhong Huayi Compressor's Earnings Growth And 12% ROE

To begin with, Changhong Huayi Compressor seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 6.3%. This probably laid the ground for Changhong Huayi Compressor's significant 42% net income growth seen over the past five years. However, there could also be other causes behind this growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Changhong Huayi Compressor's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 7.4%.

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). Doing so will help them establish if the stock's future looks promising or ominous. 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 Changhong Huayi Compressor is trading on a high P/E or a low P/E, relative to its industry.

Is Changhong Huayi Compressor Making Efficient Use Of Its Profits?

The three-year median payout ratio for Changhong Huayi Compressor is 48%, which is moderately low. The company is retaining the remaining 52%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Changhong Huayi Compressor is reinvesting its earnings efficiently.

Additionally, Changhong Huayi Compressor 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.

Summary

Overall, we are quite pleased with Changhong Huayi Compressor'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. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.