It is hard to get excited after looking at XianheLtd's (SHSE:603733) recent performance, when its stock has declined 12% over the past three months. 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. Particularly, we will be paying attention to XianheLtd's ROE today.

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.

Check out our latest analysis for XianheLtd

How Is ROE Calculated?

Return on equity 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 XianheLtd is:

7.5% = CN¥529m ÷ CN¥7.1b (Based on the trailing twelve months to September 2023).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.07 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.

XianheLtd's Earnings Growth And 7.5% ROE

When you first look at it, XianheLtd's ROE doesn't look that attractive. However, the fact that the its ROE is quite higher to the industry average of 3.9% doesn't go unnoticed by us. This certainly adds some context to XianheLtd's moderate 15% net income growth seen over the past five years. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. Therefore, the growth in earnings could also be the result of other factors. Such as- high earnings retention or the company belonging to a high growth industry.

We then compared XianheLtd'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 7.7% in the same 5-year 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. Is XianheLtd fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is XianheLtd Using Its Retained Earnings Effectively?

XianheLtd has a healthy combination of a moderate three-year median payout ratio of 31% (or a retention ratio of 69%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Additionally, XianheLtd has paid dividends over a period of five years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 25% of its profits over the next three years. Still, forecasts suggest that XianheLtd's future ROE will rise to 14% even though the the company's payout ratio is not expected to change by much.

Conclusion

Overall, we are quite pleased with XianheLtd's performance. Specifically, we like that it has been reinvesting a high portion of its profits at a moderate rate of return, resulting in earnings expansion. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.