With its stock down 7.1% over the past week, it is easy to disregard Shanxi Huaxiang Group (SHSE:603112). However, stock prices are usually driven by a company's financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Shanxi Huaxiang Group's ROE.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Shanxi Huaxiang Group

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 Shanxi Huaxiang Group is:

7.3% = CN¥193m ÷ CN¥2.6b (Based on the trailing twelve months to June 2023).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.07 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Shanxi Huaxiang Group's Earnings Growth And 7.3% ROE

At first glance, Shanxi Huaxiang Group's ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 7.6%, we may spare it some thought. Even so, Shanxi Huaxiang Group has shown a fairly decent growth in its net income which grew at a rate of 14%. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Shanxi Huaxiang Group'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 11%.

Earnings growth is an important metric to consider when valuing a stock. 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 Shanxi Huaxiang Group is trading on a high P/E or a low P/E, relative to its industry.

Is Shanxi Huaxiang Group Making Efficient Use Of Its Profits?

Shanxi Huaxiang Group has a healthy combination of a moderate three-year median payout ratio of 28% (or a retention ratio of 72%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Along with seeing a growth in earnings, Shanxi Huaxiang Group only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders.

Conclusion

On the whole, we do feel that Shanxi Huaxiang Group has some positive attributes. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 1 risk we have identified for Shanxi Huaxiang Group by visiting our risks dashboard for free on our platform here.

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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.