Guizhou Chanhen Chemical (SZSE:002895) has had a great run on the share market with its stock up by a significant 17% over the last month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Particularly, we will be paying attention to Guizhou Chanhen Chemical's ROE today.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
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 Guizhou Chanhen Chemical is:
13% = CN¥684m ÷ CN¥5.2b (Based on the trailing twelve months to September 2023).
The 'return' refers to a company's earnings over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.13.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.
A Side By Side comparison of Guizhou Chanhen Chemical's Earnings Growth And 13% ROE
To start with, Guizhou Chanhen Chemical's ROE looks acceptable. On comparing with the average industry ROE of 7.0% the company's ROE looks pretty remarkable. This certainly adds some context to Guizhou Chanhen Chemical's exceptional 45% net income growth seen over the past five years. However, there could also be other causes behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.
As a next step, we compared Guizhou Chanhen Chemical'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 12%.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 Guizhou Chanhen Chemical is trading on a high P/E or a low P/E, relative to its industry.
Is Guizhou Chanhen Chemical Efficiently Re-investing Its Profits?
The three-year median payout ratio for Guizhou Chanhen Chemical is 43%, which is moderately low. The company is retaining the remaining 57%. By the looks of it, the dividend is well covered and Guizhou Chanhen Chemical is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.
Besides, Guizhou Chanhen Chemical has been paying dividends over a period of six years. This shows that the company is committed to sharing profits with its shareholders.
Summary
On the whole, we feel that Guizhou Chanhen Chemical'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. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.