Yangzhou Chenhua New Material's (SZSE:300610) stock is up by a considerable 48% over the past month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Yangzhou Chenhua New Material's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. 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 Yangzhou Chenhua New Material

How Do You Calculate Return On Equity?

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 Yangzhou Chenhua New Material is:

13% = CN¥143m ÷ CN¥1.1b (Based on the trailing twelve months to March 2022).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.13 in profit.

Why Is ROE Important For Earnings Growth?

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

Yangzhou Chenhua New Material's Earnings Growth And 13% ROE

To begin with, Yangzhou Chenhua New Material seems to have a respectable ROE. On comparing with the average industry ROE of 10% the company's ROE looks pretty remarkable. This certainly adds some context to Yangzhou Chenhua New Material's exceptional 21% net income growth seen over the past five years. However, there could also be other causes behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Yangzhou Chenhua New Material's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average 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. 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 Yangzhou Chenhua New Material is trading on a high P/E or a low P/E, relative to its industry.

Is Yangzhou Chenhua New Material Using Its Retained Earnings Effectively?

Yangzhou Chenhua New Material's ' three-year median payout ratio is on the lower side at 24% implying that it is retaining a higher percentage (76%) 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, Yangzhou Chenhua New Material is determined to keep sharing its profits with shareholders which we infer from its long history of five years of paying a dividend.

Conclusion

Overall, we are quite pleased with Yangzhou Chenhua New Material'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. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.