Most readers would already be aware that Shanxi Huaxiang Group's (SHSE:603112) stock increased significantly by 11% over the past week. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on Shanxi Huaxiang Group's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Shanxi Huaxiang Group

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Shanxi Huaxiang Group is:

13% = CN¥335m ÷ CN¥2.5b (Based on the trailing twelve months to March 2022).

The 'return' is the yearly profit. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.13 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. 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 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.

Shanxi Huaxiang Group's Earnings Growth And 13% ROE

At first glance, Shanxi Huaxiang Group seems to have a decent ROE. Especially when compared to the industry average of 8.2% the company's ROE looks pretty impressive. This certainly adds some context to Shanxi Huaxiang Group's exceptional 26% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Shanxi Huaxiang Group'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 14%.

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. Is Shanxi Huaxiang Group fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Shanxi Huaxiang Group Using Its Retained Earnings Effectively?

Shanxi Huaxiang Group has a three-year median payout ratio of 26% (where it is retaining 74% of its income) which is not too low or not too high. So it seems that Shanxi Huaxiang Group is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

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

Conclusion

On the whole, we feel that Shanxi Huaxiang Group's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. You can see the 2 risks we have identified for Shanxi Huaxiang Group by visiting our risks dashboard for free on our platform here.

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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.