Huaihe Energy (Group) Co.,Ltd (SHSE:600575) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?

Huaihe Energy (Group)Ltd (SHSE:600575) has had a great run on the share market with its stock up by a significant 16% over the last three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. In this article, we decided to focus on Huaihe Energy (Group)Ltd'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. 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 Huaihe Energy (Group)Ltd

How Do You Calculate Return On Equity?

ROE 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 Huaihe Energy (Group)Ltd is:

8.0% = CN¥1.0b ÷ CN¥13b (Based on the trailing twelve months to March 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¥0.08 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. 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.

Huaihe Energy (Group)Ltd's Earnings Growth And 8.0% ROE

When you first look at it, Huaihe Energy (Group)Ltd'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. But seeing Huaihe Energy (Group)Ltd's five year net income decline of 5.9% 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.

That being said, we compared Huaihe Energy (Group)Ltd's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 4.9% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Huaihe Energy (Group)Ltd is trading on a high P/E or a low P/E, relative to its industry.

Is Huaihe Energy (Group)Ltd Using Its Retained Earnings Effectively?

Huaihe Energy (Group)Ltd's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 51% (or a retention ratio of 49%). With only very little left to reinvest into the business, growth in earnings is far from likely.

In addition, Huaihe Energy (Group)Ltd has been paying dividends over a period of four years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.

Conclusion

On the whole, we feel that the performance shown by Huaihe Energy (Group)Ltd can be open to many interpretations. Primarily, we are disappointed to see a lack of growth in earnings even in spite of a moderate ROE. Bear in mind, the company reinvests a small portion of its profits, which explains the lack of growth. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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

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.