Huafon Chemical Co.,Ltd's (SZSE:002064) Stock On An Uptrend: Could Fundamentals Be Driving The Momentum?

Huafon ChemicalLtd's (SZSE:002064) stock is up by a considerable 8.4% over the past week. 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. In this article, we decided to focus on Huafon ChemicalLtd's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Huafon ChemicalLtd

How To 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 Huafon ChemicalLtd is:

9.9% = CN¥2.5b ÷ CN¥26b (Based on the trailing twelve months to March 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.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 Huafon ChemicalLtd's Earnings Growth And 9.9% ROE

When you first look at it, Huafon ChemicalLtd's ROE doesn't look that attractive. However, the fact that the its ROE is quite higher to the industry average of 6.3% doesn't go unnoticed by us. Consequently, this likely laid the ground for the decent growth of 5.8% seen over the past five years by Huafon ChemicalLtd. That being said, the company does have a slightly low ROE to begin with, just that it is higher than the industry average. So there might well be other reasons for the earnings to grow. For example, it is possible that the broader industry is going through a high growth phase, or that the company has a low payout ratio.

As a next step, we compared Huafon ChemicalLtd's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 7.5% in the same period.

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). 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 Huafon ChemicalLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Huafon ChemicalLtd Using Its Retained Earnings Effectively?

Huafon ChemicalLtd has a three-year median payout ratio of 26%, which implies that it retains the remaining 74% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Besides, Huafon ChemicalLtd has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.

Summary

On the whole, we do feel that Huafon ChemicalLtd has some positive attributes. Particularly, its earnings have grown respectably as we saw earlier, which was likely achieved due to the company reinvesting most of its earnings at a decent rate of return, to grow its business. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.

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