Guangdong Huate Gas' (SHSE:688268) stock is up by a considerable 28% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Guangdong Huate Gas' ROE in this article.

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.

Check out our latest analysis for Guangdong Huate Gas

How Do You Calculate Return On Equity?

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 Guangdong Huate Gas is:

7.7% = CN¥143m ÷ CN¥1.8b (Based on the trailing twelve months to September 2023).

The 'return' is the income the business earned over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.08.

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. 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.

Guangdong Huate Gas' Earnings Growth And 7.7% ROE

On the face of it, Guangdong Huate Gas' ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 6.7%. Moreover, we are quite pleased to see that Guangdong Huate Gas' net income grew significantly at a rate of 24% over the last five years. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings 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 Guangdong Huate Gas' 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 12% in the same 5-year period.

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

Is Guangdong Huate Gas Using Its Retained Earnings Effectively?

Guangdong Huate Gas has a three-year median payout ratio of 30% (where it is retaining 70% of its income) which is not too low or not too high. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Guangdong Huate Gas is reinvesting its earnings efficiently.

Moreover, Guangdong Huate Gas is determined to keep sharing its profits with shareholders which we infer from its long history of three years of paying a dividend. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 25% of its profits over the next three years. Still, forecasts suggest that Guangdong Huate Gas' future ROE will rise to 16% even though the the company's payout ratio is not expected to change by much.

Summary

On the whole, we do feel that Guangdong Huate Gas has some positive attributes. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.