Most readers would already be aware that China Shenhua Energy's (HKG:1088) stock increased significantly by 12% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to China Shenhua Energy's ROE today.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for China Shenhua Energy is:

13% = CN¥67b ÷ CN¥503b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.13.

Why Is ROE Important For 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. 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 China Shenhua Energy's Earnings Growth And 13% ROE

To start with, China Shenhua Energy's ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 12%. This certainly adds some context to China Shenhua Energy's moderate 12% net income growth seen over the past five years.

We then compared China Shenhua Energy's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 27% in the same 5-year period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is 1088 worth today? The intrinsic value infographic in our free research report helps visualize whether 1088 is currently mispriced by the market.

Is China Shenhua Energy Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 79% (or a retention ratio of 21%) for China Shenhua Energy suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Moreover, China Shenhua Energy 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 72% of its profits over the next three years. Accordingly, forecasts suggest that China Shenhua Energy's future ROE will be 13% which is again, similar to the current ROE.

Summary

In total, it does look like China Shenhua Energy has some positive aspects to its business. Its earnings have grown respectably as we saw earlier, which was likely due to the company reinvesting its earnings at a pretty high rate of return. However, given the high ROE, we do think that the company is reinvesting a small portion of its profits. This could likely be preventing the company from growing to its full extent. 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. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.