Is Weakness In Shanghai Huafon Aluminium Corporation (SHSE:601702) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

Shanghai Huafon Aluminium (SHSE:601702) has had a rough three months with its share price down 16%. 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 Shanghai Huafon Aluminium's ROE in this article.

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.

Check out our latest analysis for Shanghai Huafon Aluminium

How To Calculate Return On Equity?

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 Shanghai Huafon Aluminium is:

21% = CN¥983m ÷ CN¥4.8b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.21 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of Shanghai Huafon Aluminium's Earnings Growth And 21% ROE

To start with, Shanghai Huafon Aluminium's ROE looks acceptable. On comparing with the average industry ROE of 7.4% the company's ROE looks pretty remarkable. This certainly adds some context to Shanghai Huafon Aluminium's exceptional 37% net income growth seen over the past five years. However, there could also be other causes behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared Shanghai Huafon Aluminium's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 11% 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. If you're wondering about Shanghai Huafon Aluminium's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shanghai Huafon Aluminium Using Its Retained Earnings Effectively?

Shanghai Huafon Aluminium's three-year median payout ratio to shareholders is 13%, which is quite low. This implies that the company is retaining 87% of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

Besides, Shanghai Huafon Aluminium has been paying dividends over a period of three years. This shows that the company is committed to sharing profits with its shareholders.

Summary

On the whole, we feel that Shanghai Huafon Aluminium's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. To know the 1 risk we have identified for Shanghai Huafon Aluminium visit our risks dashboard for free.

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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.

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