Huaming Power Equipment Co.,Ltd's (SZSE:002270) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

With its stock down 29% over the past three months, it is easy to disregard Huaming Power EquipmentLtd (SZSE:002270). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Huaming Power EquipmentLtd's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Huaming Power EquipmentLtd

How Do You Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for Huaming Power EquipmentLtd is:

18% = CN¥578m ÷ CN¥3.2b (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.18 in profit.

What Is The Relationship Between ROE And 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.

Huaming Power EquipmentLtd's Earnings Growth And 18% ROE

To start with, Huaming Power EquipmentLtd's ROE looks acceptable. On comparing with the average industry ROE of 7.0% the company's ROE looks pretty remarkable. This certainly adds some context to Huaming Power EquipmentLtd's exceptional 20% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that Huaming Power EquipmentLtd's growth is quite high when compared to the industry average growth of 8.8% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for 002270? You can find out in our latest intrinsic value infographic research report.

Is Huaming Power EquipmentLtd Using Its Retained Earnings Effectively?

The really high three-year median payout ratio of 103% for Huaming Power EquipmentLtd suggests that the company is paying its shareholders more than what it is earning. In spite of this, the company was able to grow its earnings significantly, as we saw above. With that said, it could be worth keeping an eye on the high payout ratio as that's a huge risk.

Additionally, Huaming Power EquipmentLtd has paid dividends over a period of nine years which means that the company is pretty serious about sharing its profits with shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 79% over the next three years. The fact that the company's ROE is expected to rise to 23% over the same period is explained by the drop in the payout ratio.

Conclusion

On the whole, we do feel that Huaming Power EquipmentLtd has some positive attributes. Specifically, its high ROE which likely led to the growth in earnings. Bear in mind, the company reinvests little to none of its profits, which means that investors aren't necessarily reaping the full benefits of the high rate of return. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.