Hubei Forbon TechnologyLtd (SZSE:300387) has had a great run on the share market with its stock up by a significant 48% over the last three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on Hubei Forbon TechnologyLtd'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How Is ROE Calculated?

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 Hubei Forbon TechnologyLtd is:

5.5% = CN¥76m ÷ CN¥1.4b (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.05.

What Is The Relationship Between ROE And 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.

A Side By Side comparison of Hubei Forbon TechnologyLtd's Earnings Growth And 5.5% ROE

At first glance, Hubei Forbon TechnologyLtd's ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 6.3%. But then again, Hubei Forbon TechnologyLtd's five year net income shrunk at a rate of 2.7%. Remember, the company's ROE is a bit low to begin with. Hence, this goes some way in explaining the shrinking earnings.

So, as a next step, we compared Hubei Forbon TechnologyLtd'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 8.4% over the last few years.

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. If you're wondering about Hubei Forbon TechnologyLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Hubei Forbon TechnologyLtd Making Efficient Use Of Its Profits?

In spite of a normal three-year median payout ratio of 28% (that is, a retention ratio of 72%), the fact that Hubei Forbon TechnologyLtd's earnings have shrunk is quite puzzling. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, Hubei Forbon TechnologyLtd has paid dividends over a period of nine years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Summary

In total, we're a bit ambivalent about Hubei Forbon TechnologyLtd's performance. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. You can see the 2 risks we have identified for Hubei Forbon TechnologyLtd by visiting our risks dashboard for free on our platform here.

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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.