With its stock down 12% over the past three months, it is easy to disregard Lao Feng Xiang (SHSE:600612). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Lao Feng Xiang's ROE in this article.

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.

See our latest analysis for Lao Feng Xiang

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 Lao Feng Xiang is:

22% = CN¥2.8b ÷ CN¥13b (Based on the trailing twelve months to June 2023).

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¥0.22 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. 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. 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.

A Side By Side comparison of Lao Feng Xiang's Earnings Growth And 22% ROE

To begin with, Lao Feng Xiang seems to have a respectable ROE. Especially when compared to the industry average of 6.9% the company's ROE looks pretty impressive. Probably as a result of this, Lao Feng Xiang was able to see a decent growth of 10% over the last five years.

As a next step, we compared Lao Feng Xiang'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 2.8%.

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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Lao Feng Xiang's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Lao Feng Xiang Making Efficient Use Of Its Profits?

With a three-year median payout ratio of 41% (implying that the company retains 59% of its profits), it seems that Lao Feng Xiang is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Besides, Lao Feng Xiang has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 37%. Accordingly, forecasts suggest that Lao Feng Xiang's future ROE will be 20% which is again, similar to the current ROE.

Summary

On the whole, we feel that Lao Feng Xiang's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. The latest industry analyst forecasts show that the company is expected to maintain its current 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.