With its stock down 38% over the past three months, it is easy to disregard Sichuan Huiyuan Optical Communication (SZSE:000586). However, stock prices are usually driven by a company's financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Sichuan Huiyuan Optical Communication's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

How To 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 Sichuan Huiyuan Optical Communication is:

5.6% = CN¥19m ÷ CN¥340m (Based on the trailing twelve months to September 2023).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.06 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Sichuan Huiyuan Optical Communication's Earnings Growth And 5.6% ROE

At first glance, Sichuan Huiyuan Optical Communication's ROE doesn't look very promising. However, its ROE is similar to the industry average of 6.7%, so we won't completely dismiss the company. Particularly, the exceptional 32% net income growth seen by Sichuan Huiyuan Optical Communication over the past five years is pretty remarkable. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Sichuan Huiyuan Optical Communication's growth is quite high when compared to the industry average growth of 13% in the same period, which is great to see.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is Sichuan Huiyuan Optical Communication fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Sichuan Huiyuan Optical Communication Using Its Retained Earnings Effectively?

Sichuan Huiyuan Optical Communication doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the high earnings growth number that we discussed above.

Conclusion

In total, it does look like Sichuan Huiyuan Optical Communication has some positive aspects to its business. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. 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. Our risks dashboard would have the 2 risks we have identified for Sichuan Huiyuan Optical Communication.

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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.