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

It is hard to get excited after looking at Shanghai Huafon Aluminium's (SHSE:601702) recent performance, when its stock has declined 3.7% over the past month. 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 key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Shanghai Huafon Aluminium

How To Calculate Return On Equity?

Return on equity 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¥1.0b ÷ CN¥4.9b (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.21.

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. 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.

Shanghai Huafon Aluminium's Earnings Growth And 21% ROE

At first glance, Shanghai Huafon Aluminium seems to have a decent ROE. Especially when compared to the industry average of 7.4% the company's ROE looks pretty impressive. This probably laid the ground for Shanghai Huafon Aluminium's significant 36% net income growth seen over the past five years. We reckon that there could also be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

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 9.3% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. 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 Making Efficient Use Of Its Profits?

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 looks like Shanghai Huafon Aluminium is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Moreover, Shanghai Huafon Aluminium is determined to keep sharing its profits with shareholders which we infer from its long history of four years of paying a dividend. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 20% over the next three years. However, the company's ROE is not expected to change by much despite the higher expected payout ratio.

Summary

In total, we are pretty happy with Shanghai Huafon Aluminium's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.

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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.