With its stock down 10% over the past three months, it is easy to disregard Shanghai Hanbell Precise Machinery (SZSE:002158). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Shanghai Hanbell Precise Machinery's ROE today.

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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How To Calculate Return On Equity?

Return on equity 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 Shanghai Hanbell Precise Machinery is:

27% = CN¥861m ÷ CN¥3.2b (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.27 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. 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.

Shanghai Hanbell Precise Machinery's Earnings Growth And 27% ROE

Firstly, we acknowledge that Shanghai Hanbell Precise Machinery has a significantly high ROE. Secondly, even when compared to the industry average of 7.5% the company's ROE is quite impressive. Under the circumstances, Shanghai Hanbell Precise Machinery's considerable five year net income growth of 30% was to be expected.

We then compared Shanghai Hanbell Precise Machinery'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 11% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Shanghai Hanbell Precise Machinery's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shanghai Hanbell Precise Machinery Making Efficient Use Of Its Profits?

Shanghai Hanbell Precise Machinery's three-year median payout ratio is a pretty moderate 37%, meaning the company retains 63% of its income. So it seems that Shanghai Hanbell Precise Machinery is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Moreover, Shanghai Hanbell Precise Machinery is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 36%. Accordingly, forecasts suggest that Shanghai Hanbell Precise Machinery's future ROE will be 23% which is again, similar to the current ROE.

Conclusion

In total, we are pretty happy with Shanghai Hanbell Precise Machinery's performance. 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. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.