ZheJiang HuaSheng TechnologyLtd (SHSE:605180) has had a rough three months with its share price down 26%. However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to ZheJiang HuaSheng TechnologyLtd's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for ZheJiang HuaSheng TechnologyLtd

How To Calculate Return On Equity?

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 ZheJiang HuaSheng TechnologyLtd is:

16% = CN¥180m ÷ CN¥1.1b (Based on the trailing twelve months to March 2022).

The 'return' is the yearly profit. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.16 in profit.

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.

ZheJiang HuaSheng TechnologyLtd's Earnings Growth And 16% ROE

To start with, ZheJiang HuaSheng TechnologyLtd's ROE looks acceptable. On comparing with the average industry ROE of 10% the company's ROE looks pretty remarkable. Probably as a result of this, ZheJiang HuaSheng TechnologyLtd was able to see an impressive net income growth of 30% over the last five years. However, there could also be other causes behind this growth. Such as - high earnings retention or an efficient management in place.

We then compared ZheJiang HuaSheng TechnologyLtd's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 19% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 ZheJiang HuaSheng TechnologyLtd is trading on a high P/E or a low P/E, relative to its industry.

Is ZheJiang HuaSheng TechnologyLtd Using Its Retained Earnings Effectively?

ZheJiang HuaSheng TechnologyLtd doesn't pay any dividend to its shareholders, meaning that the company has been reinvesting all of its profits into the business. This is likely what's driving the high earnings growth number discussed above.

Conclusion

In total, we are pretty happy with ZheJiang HuaSheng TechnologyLtd'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. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. To know the 1 risk we have identified for ZheJiang HuaSheng TechnologyLtd visit our risks dashboard for free.

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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.