Jiangsu Hengshun Vinegar-IndustryLtd's (SHSE:600305) stock is up by 3.1% over the past week. However, in this article, we decided to focus on its weak financials, as long-term fundamentals ultimately dictate market outcomes. Specifically, we decided to study Jiangsu Hengshun Vinegar-IndustryLtd's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Jiangsu Hengshun Vinegar-IndustryLtd

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Jiangsu Hengshun Vinegar-IndustryLtd is:

5.5% = CN¥126m ÷ CN¥2.3b (Based on the trailing twelve months to March 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¥0.06 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Jiangsu Hengshun Vinegar-IndustryLtd's Earnings Growth And 5.5% ROE

On the face of it, Jiangsu Hengshun Vinegar-IndustryLtd's ROE is not much to talk about. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 8.1%. Given the circumstances, the significant decline in net income by 18% seen by Jiangsu Hengshun Vinegar-IndustryLtd over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.

That being said, we compared Jiangsu Hengshun Vinegar-IndustryLtd's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 3.3% in the same 5-year period.

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). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Jiangsu Hengshun Vinegar-IndustryLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Jiangsu Hengshun Vinegar-IndustryLtd Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 72% (implying that 28% of the profits are retained), most of Jiangsu Hengshun Vinegar-IndustryLtd's profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 2 risks we have identified for Jiangsu Hengshun Vinegar-IndustryLtd by visiting our risks dashboard for free on our platform here.

In addition, Jiangsu Hengshun Vinegar-IndustryLtd has been paying dividends over a period of nine years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 76%. Regardless, the future ROE for Jiangsu Hengshun Vinegar-IndustryLtd is predicted to rise to 12% despite there being not much change expected in its payout ratio.

Conclusion

Overall, we would be extremely cautious before making any decision on Jiangsu Hengshun Vinegar-IndustryLtd. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.