Most readers would already know that Anhui Guangxin Agrochemical's (SHSE:603599) stock increased by 4.8% over the past week. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Anhui Guangxin Agrochemical's ROE in this article.

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.

See our latest analysis for Anhui Guangxin Agrochemical

How Is ROE Calculated?

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 Anhui Guangxin Agrochemical is:

27% = CN¥2.1b ÷ CN¥7.9b (Based on the trailing twelve months to June 2022).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.27 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

Anhui Guangxin Agrochemical's Earnings Growth And 27% ROE

To begin with, Anhui Guangxin Agrochemical has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 11% the company's ROE is quite impressive. So, the substantial 38% net income growth seen by Anhui Guangxin Agrochemical over the past five years isn't overly surprising.

As a next step, we compared Anhui Guangxin Agrochemical'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 19%.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Anhui Guangxin Agrochemical is trading on a high P/E or a low P/E, relative to its industry.

Is Anhui Guangxin Agrochemical Using Its Retained Earnings Effectively?

Anhui Guangxin Agrochemical's three-year median payout ratio to shareholders is 22%, which is quite low. This implies that the company is retaining 78% of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Moreover, Anhui Guangxin Agrochemical is determined to keep sharing its profits with shareholders which we infer from its long history of six years of paying a dividend.

Summary

Overall, we are quite pleased with Anhui Guangxin Agrochemical's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. 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 latest analysts predictions for the company, check out this visualization of analyst forecasts 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.