Most readers would already be aware that Fufeng Group's (HKG:546) stock increased significantly by 56% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to Fufeng Group's ROE today.

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. 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 Fufeng 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 Fufeng Group is:

10% = CN¥1.3b ÷ CN¥13b (Based on the trailing twelve months to December 2021).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each HK$1 of shareholders' capital it has, the company made HK$0.10 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

Fufeng Group's Earnings Growth And 10% ROE

At first glance, Fufeng Group seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 12%. As you might expect, the 7.9% net income decline reported by Fufeng Group is a bit of a surprise. We reckon that there could be some other factors at play here that are preventing the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

So, as a next step, we compared Fufeng Group's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 13% in the same period.

Earnings growth is a huge factor in stock valuation. 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. Is Fufeng Group fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Fufeng Group Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 35% (where it is retaining 65% of its profits), Fufeng Group has seen a decline in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Moreover, Fufeng Group has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 14% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.

Conclusion

In total, it does look like Fufeng Group has some positive aspects to its business. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.