Huali University Group Limited's (HKG:1756) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

It is hard to get excited after looking at Huali University Group's (HKG:1756) recent performance, when its stock has declined 4.5% over the past week. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Huali University 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Huali University Group

How To 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 Huali University Group is:

11% = CN¥307m ÷ CN¥2.7b (Based on the trailing twelve months to August 2020).

The 'return' is the yearly profit. Another way to think of that is that for every HK$1 worth of equity, the company was able to earn HK$0.11 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Huali University Group's Earnings Growth And 11% ROE

To begin with, Huali University Group seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 11%. Consequently, this likely laid the ground for the decent growth of 10% seen over the past five years by Huali University Group.

Next, on comparing with the industry net income growth, we found that Huali University Group's reported growth was lower than the industry growth of 19% in the same period, which is not something we like to see.

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). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Huali University Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Huali University Group Using Its Retained Earnings Effectively?

Huali University Group has a low three-year median payout ratio of 22%, meaning that the company retains the remaining 78% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

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

Conclusion

In total, we are pretty happy with Huali University Group's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. 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 would have the 2 risks we have identified for Huali University Group.

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This article by Simply Wall St is general in nature. 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.
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