Shandong Longhua New Material Co., Ltd.'s (SZSE:301149) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

Shandong Longhua New Material (SZSE:301149) has had a rough month with its share price down 19%. 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. Particularly, we will be paying attention to Shandong Longhua New Material's ROE today.

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.

Check out our latest analysis for Shandong Longhua New Material

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 Shandong Longhua New Material is:

13% = CN¥255m ÷ CN¥1.9b (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.13 in profit.

What Has ROE Got To Do With 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. 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 Shandong Longhua New Material's Earnings Growth And 13% ROE

To begin with, Shandong Longhua New Material seems to have a respectable ROE. Especially when compared to the industry average of 6.3% the company's ROE looks pretty impressive. This probably laid the ground for Shandong Longhua New Material's moderate 20% net income growth seen over the past five years.

As a next step, we compared Shandong Longhua New Material's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 7.9%.

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 Shandong Longhua New Material's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shandong Longhua New Material Using Its Retained Earnings Effectively?

With a three-year median payout ratio of 26% (implying that the company retains 74% of its profits), it seems that Shandong Longhua New Material is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

While Shandong Longhua New Material has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 34% over the next three years. Regardless, the future ROE for Shandong Longhua New Material is speculated to rise to 22% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.

Conclusion

In total, we are pretty happy with Shandong Longhua New Material'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. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.