Huafon Chemical Co.,Ltd's (SZSE:002064) Stock Is Going Strong: Have Financials A Role To Play?

Most readers would already be aware that Huafon ChemicalLtd's (SZSE:002064) stock increased significantly by 18% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Huafon ChemicalLtd's ROE.

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.

View our latest analysis for Huafon ChemicalLtd

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 Huafon ChemicalLtd is:

9.8% = CN¥2.6b ÷ CN¥26b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.10 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. 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.

Huafon ChemicalLtd's Earnings Growth And 9.8% ROE

When you first look at it, Huafon ChemicalLtd's ROE doesn't look that attractive. However, the fact that the company's ROE is higher than the average industry ROE of 6.2%, is definitely interesting. Having said that, Huafon ChemicalLtd's net income growth over the past five years is more or less flat. Bear in mind, the company does have a slightly low ROE. It is just that the industry ROE is lower. So that could be one of the factors that are causing earnings growth to stay flat.

Next, on comparing with the industry net income growth, we found that the industry grew its earnings by 4.9% over the last few years.

Earnings growth is a huge factor in stock valuation. 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. If you're wondering about Huafon ChemicalLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Huafon ChemicalLtd Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 29% (or a retention ratio of 71%), Huafon ChemicalLtd hasn't seen much growth in its earnings. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

In addition, Huafon ChemicalLtd has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Conclusion

On the whole, we do feel that Huafon ChemicalLtd has some positive attributes. However, while the company does have a decent ROE and a high profit retention, its earnings growth number is quite disappointing. This suggests that there might be some external threat to the business, that's hampering growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.