Are Strong Financial Prospects The Force That Is Driving The Momentum In Hengong Precision Equipment Co., Ltd.'s SZSE:301261) Stock?

Hengong Precision Equipment's (SZSE:301261) stock is up by a considerable 51% over the past month. 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 Hengong Precision Equipment'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Hengong Precision Equipment

How Is ROE Calculated?

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 Hengong Precision Equipment is:

9.0% = CN¥141m ÷ CN¥1.6b (Based on the trailing twelve months to September 2024).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.09 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 Hengong Precision Equipment's Earnings Growth And 9.0% ROE

On the face of it, Hengong Precision Equipment's ROE is not much to talk about. Although a closer study shows that the company's ROE is higher than the industry average of 7.5% which we definitely can't overlook. Especially when you consider Hengong Precision Equipment's exceptional 21% net income growth over the past five years. 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. E.g the company has a low payout ratio or could belong to a high growth industry.

We then compared Hengong Precision Equipment'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 9.8% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. 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. Is Hengong Precision Equipment fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Hengong Precision Equipment Using Its Retained Earnings Effectively?

The three-year median payout ratio for Hengong Precision Equipment is 28%, which is moderately low. The company is retaining the remaining 72%. By the looks of it, the dividend is well covered and Hengong Precision Equipment is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Along with seeing a growth in earnings, Hengong Precision Equipment only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders.

Summary

On the whole, we feel that Hengong Precision Equipment's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. 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.