Is Shanxi Huhua Group Co., Ltd.'s (SZSE:003002) Latest Stock Performance A Reflection Of Its Financial Health?

Shanxi Huhua Group (SZSE:003002) has had a great run on the share market with its stock up by a significant 93% over the last three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. In this article, we decided to focus on Shanxi Huhua Group's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Shanxi Huhua Group

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 Shanxi Huhua Group is:

15% = CN¥216m ÷ CN¥1.4b (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.15 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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.

Shanxi Huhua Group's Earnings Growth And 15% ROE

To begin with, Shanxi Huhua Group seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 6.4%. Probably as a result of this, Shanxi Huhua Group was able to see an impressive net income growth of 22% over the last five years. However, there could also be other causes behind this growth. 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 Shanxi Huhua Group'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 6.3% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Shanxi Huhua Group is trading on a high P/E or a low P/E, relative to its industry.

Is Shanxi Huhua Group Using Its Retained Earnings Effectively?

The three-year median payout ratio for Shanxi Huhua Group is 36%, which is moderately low. The company is retaining the remaining 64%. So it seems that Shanxi Huhua Group is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Moreover, Shanxi Huhua Group is determined to keep sharing its profits with shareholders which we infer from its long history of three years of paying a dividend.

Summary

Overall, we are quite pleased with Shanxi Huhua Group's performance. 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. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. Our risks dashboard will have the 1 risk we have identified for Shanxi Huhua Group.

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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.