Lihuayi Weiyuan Chemical's (SHSE:600955) stock is up by 4.9% over the past week. However, we decided to study the company's mixed-bag of fundamentals to assess what this could mean for future share prices, as stock prices tend to be aligned with a company's long-term financial performance. Particularly, we will be paying attention to Lihuayi Weiyuan Chemical'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Lihuayi Weiyuan Chemical

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 Lihuayi Weiyuan Chemical is:

2.4% = CN¥204m ÷ CN¥8.6b (Based on the trailing twelve months to September 2023).

The 'return' refers to a company's earnings over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.02 in profit.

What Has ROE Got To Do With Earnings Growth?

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

Lihuayi Weiyuan Chemical's Earnings Growth And 2.4% ROE

As you can see, Lihuayi Weiyuan Chemical's ROE looks pretty weak. Not just that, even compared to the industry average of 6.8%, the company's ROE is entirely unremarkable. Hence, the flat earnings seen by Lihuayi Weiyuan Chemical over the past five years could probably be the result of it having a lower ROE.

Next, on comparing with the industry net income growth, we found that the industry grew its earnings by 12% over the last few years.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is Lihuayi Weiyuan Chemical fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Lihuayi Weiyuan Chemical Using Its Retained Earnings Effectively?

Lihuayi Weiyuan Chemical has a low three-year median payout ratio of 21% (or a retention ratio of 79%) but the negligible earnings growth number doesn't reflect this as high growth usually follows high profit retention.

In addition, Lihuayi Weiyuan Chemical only recently started paying a dividend so the management must have decided the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 15% over the next three years. As a result, the expected drop in Lihuayi Weiyuan Chemical's payout ratio explains the anticipated rise in the company's future ROE to 8.9%, over the same period.

Conclusion

On the whole, we feel that the performance shown by Lihuayi Weiyuan Chemical can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.