With its stock down 24% over the past month, it is easy to disregard Zhejiang Yonghe Refrigerant (SHSE:605020). However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Zhejiang Yonghe Refrigerant's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Do You 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 Zhejiang Yonghe Refrigerant is:

9.0% = CN¥235m ÷ CN¥2.6b (Based on the trailing twelve months to September 2023).

The 'return' refers to a company's earnings over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.09.

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. 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.

Zhejiang Yonghe Refrigerant's Earnings Growth And 9.0% ROE

When you first look at it, Zhejiang Yonghe Refrigerant's ROE doesn't look that attractive. However, the fact that the its ROE is quite higher to the industry average of 7.1% doesn't go unnoticed by us. Consequently, this likely laid the ground for the decent growth of 18% seen over the past five years by Zhejiang Yonghe Refrigerant. That being said, the company does have a slightly low ROE to begin with, just that it is higher than the industry average. Therefore, the growth in earnings could also be the result of other factors. For example, it is possible that the broader industry is going through a high growth phase, or that the company has a low payout ratio.

Next, on comparing with the industry net income growth, we found that Zhejiang Yonghe Refrigerant's growth is quite high when compared to the industry average growth of 11% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Is Zhejiang Yonghe Refrigerant fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Zhejiang Yonghe Refrigerant Efficiently Re-investing Its Profits?

Zhejiang Yonghe Refrigerant's three-year median payout ratio to shareholders is 22% (implying that it retains 78% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Along with seeing a growth in earnings, Zhejiang Yonghe Refrigerant only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 28% over the next three years. Regardless, the future ROE for Zhejiang Yonghe Refrigerant is speculated to rise to 21% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.

Conclusion

On the whole, we feel that Zhejiang Yonghe Refrigerant's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.