Most readers would already be aware that Guangzhou Hexin InstrumentLtd's (SHSE:688622) stock increased significantly by 38% 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. Specifically, we decided to study Guangzhou Hexin InstrumentLtd's ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Guangzhou Hexin InstrumentLtd

How To 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 Guangzhou Hexin InstrumentLtd is:

9.7% = CN¥56m ÷ CN¥582m (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¥0.10 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. 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.

A Side By Side comparison of Guangzhou Hexin InstrumentLtd's Earnings Growth And 9.7% ROE

When you first look at it, Guangzhou Hexin InstrumentLtd's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 9.0%. Looking at Guangzhou Hexin InstrumentLtd's exceptional 31% five-year net income growth in particular, we are definitely impressed. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Guangzhou Hexin InstrumentLtd'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 16%.

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 Guangzhou Hexin InstrumentLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Guangzhou Hexin InstrumentLtd Efficiently Re-investing Its Profits?

Guangzhou Hexin InstrumentLtd's three-year median payout ratio to shareholders is 14%, which is quite low. This implies that the company is retaining 86% of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

Conclusion

In total, it does look like Guangzhou Hexin InstrumentLtd has some positive aspects to its business. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard would have the 3 risks we have identified for Guangzhou Hexin InstrumentLtd.

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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.