Has Shandong Hongyu Precision Machinery Co., Ltd.'s (SZSE:002890) Impressive Stock Performance Got Anything to Do With Its Fundamentals?

Shandong Hongyu Precision Machinery (SZSE:002890) has had a great run on the share market with its stock up by a significant 22% over the last 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 Shandong Hongyu Precision Machinery'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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Shandong Hongyu Precision Machinery

How Do You 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 Shandong Hongyu Precision Machinery is:

3.3% = CN¥20m ÷ CN¥591m (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.03 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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Shandong Hongyu Precision Machinery's Earnings Growth And 3.3% ROE

It is quite clear that Shandong Hongyu Precision Machinery's ROE is rather low. Even when compared to the industry average of 6.3%, the ROE figure is pretty disappointing. Although, we can see that Shandong Hongyu Precision Machinery saw a modest net income growth of 10% over the past five years. Therefore, the growth in earnings could probably have been caused by other variables. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Shandong Hongyu Precision Machinery'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. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Shandong Hongyu Precision Machinery is trading on a high P/E or a low P/E, relative to its industry.

Is Shandong Hongyu Precision Machinery Making Efficient Use Of Its Profits?

While Shandong Hongyu Precision Machinery has a three-year median payout ratio of 53% (which means it retains 47% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.

Additionally, Shandong Hongyu Precision Machinery has paid dividends over a period of seven years which means that the company is pretty serious about sharing its profits with shareholders.

Summary

Overall, we feel that Shandong Hongyu Precision Machinery certainly does have some positive factors to consider. Namely, its high earnings growth. We do however feel that the earnings growth number could have been even higher, had the company been reinvesting more of its earnings and paid out less dividends. So far, we've only made a quick discussion around the company's earnings growth. So it may be worth checking this free detailed graph of Shandong Hongyu Precision Machinery's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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.