It is hard to get excited after looking at Changhong Huayi Compressor's (SZSE:000404) recent performance, when its stock has declined 21% over the past three months. However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Changhong Huayi Compressor'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

How Do You Calculate Return On Equity?

ROE 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 Changhong Huayi Compressor is:

12% = CN¥595m ÷ CN¥5.1b (Based on the trailing twelve months to September 2023).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.12.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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 Changhong Huayi Compressor's Earnings Growth And 12% ROE

To begin with, Changhong Huayi Compressor seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 7.6%. This probably laid the ground for Changhong Huayi Compressor's significant 44% net income growth seen over the past five years. We reckon that there could also be other factors at play here. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Changhong Huayi Compressor's growth is quite high when compared to the industry average growth of 12% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Changhong Huayi Compressor's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Changhong Huayi Compressor Using Its Retained Earnings Effectively?

The three-year median payout ratio for Changhong Huayi Compressor is 49%, which is moderately low. The company is retaining the remaining 51%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Changhong Huayi Compressor is reinvesting its earnings efficiently.

Additionally, Changhong Huayi Compressor has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders.

Summary

In total, we are pretty happy with Changhong Huayi Compressor'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. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.