Most readers would already be aware that Guizhou Zhenhua New Material's (SHSE:688707) stock increased significantly by 25% 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 Guizhou Zhenhua New Material'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.

View our latest analysis for Guizhou Zhenhua New Material

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 Guizhou Zhenhua New Material is:

21% = CN¥678m ÷ CN¥3.3b (Based on the trailing twelve months to March 2022).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.21 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

A Side By Side comparison of Guizhou Zhenhua New Material's Earnings Growth And 21% ROE

At first glance, Guizhou Zhenhua New Material seems to have a decent ROE. On comparing with the average industry ROE of 8.7% the company's ROE looks pretty remarkable. Probably as a result of this, Guizhou Zhenhua New Material was able to see an impressive net income growth of 39% over the last five years. However, there could also be other causes behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared Guizhou Zhenhua New Material'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 14% in the same 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 Guizhou Zhenhua New Material fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Guizhou Zhenhua New Material Using Its Retained Earnings Effectively?

Guizhou Zhenhua New Material has a really low three-year median payout ratio of 18%, meaning that it has the remaining 82% left over to reinvest into its business. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

Summary

In total, we are pretty happy with Guizhou Zhenhua New Material's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.