Wuxi Honghui New Materials Technology Co., Ltd.'s (SZSE:002802) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

Wuxi Honghui New Materials Technology (SZSE:002802) has had a great run on the share market with its stock up by a significant 19% over the last week. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. Particularly, we will be paying attention to Wuxi Honghui New Materials Technology's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Wuxi Honghui New Materials Technology

How Is ROE Calculated?

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 Wuxi Honghui New Materials Technology is:

8.3% = CN¥52m ÷ CN¥623m (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.08 in profit.

Why Is ROE Important For 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of Wuxi Honghui New Materials Technology's Earnings Growth And 8.3% ROE

At first glance, Wuxi Honghui New Materials Technology's ROE doesn't look very promising. However, the fact that the company's ROE is higher than the average industry ROE of 6.4%, is definitely interesting. But seeing Wuxi Honghui New Materials Technology's five year net income decline of 8.4% over the past five years, we might rethink that. Remember, the company's ROE is a bit low to begin with, just that it is higher than the industry average. Hence, this goes some way in explaining the shrinking earnings.

However, when we compared Wuxi Honghui New Materials Technology's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 6.2% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is Wuxi Honghui New Materials Technology fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Wuxi Honghui New Materials Technology Efficiently Re-investing Its Profits?

Wuxi Honghui New Materials Technology has a high three-year median payout ratio of 86% (that is, it is retaining 14% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. Our risks dashboard should have the 2 risks we have identified for Wuxi Honghui New Materials Technology.

Moreover, Wuxi Honghui New Materials Technology has been paying dividends for eight years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking.

Summary

In total, we're a bit ambivalent about Wuxi Honghui New Materials Technology's performance. On the one hand, the company does have a decent rate of return, however, its earnings growth number is quite disappointing and as discussed earlier, the low retained earnings is hampering the growth. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. To gain further insights into Wuxi Honghui New Materials Technology's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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.