Jiangsu Hengshun Vinegar-IndustryLtd (SHSE:600305) has had a rough three months with its share price down 21%. To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. Specifically, we decided to study Jiangsu Hengshun Vinegar-IndustryLtd's ROE in this article.
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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How To 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 Jiangsu Hengshun Vinegar-IndustryLtd is:
3.4% = CN¥114m ÷ CN¥3.4b (Based on the trailing twelve months to September 2023).
The 'return' is the income the business earned over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.03 in profit.
What Has ROE Got To Do With 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. 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.
Jiangsu Hengshun Vinegar-IndustryLtd's Earnings Growth And 3.4% ROE
It is quite clear that Jiangsu Hengshun Vinegar-IndustryLtd's ROE is rather low. Not just that, even compared to the industry average of 8.5%, the company's ROE is entirely unremarkable. Given the circumstances, the significant decline in net income by 23% seen by Jiangsu Hengshun Vinegar-IndustryLtd over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.
That being said, we compared Jiangsu Hengshun Vinegar-IndustryLtd's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 7.2% in the same 5-year period.
Earnings growth is an important metric to consider when valuing a stock. 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 Jiangsu Hengshun Vinegar-IndustryLtd is trading on a high P/E or a low P/E, relative to its industry.
Is Jiangsu Hengshun Vinegar-IndustryLtd Efficiently Re-investing Its Profits?
With a high three-year median payout ratio of 79% (implying that 21% of the profits are retained), most of Jiangsu Hengshun Vinegar-IndustryLtd's profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 2 risks we have identified for Jiangsu Hengshun Vinegar-IndustryLtd by visiting our risks dashboard for free on our platform here.
Additionally, Jiangsu Hengshun Vinegar-IndustryLtd has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 55% over the next three years. As a result, the expected drop in Jiangsu Hengshun Vinegar-IndustryLtd's payout ratio explains the anticipated rise in the company's future ROE to 9.6%, over the same period.
Summary
In total, we would have a hard think before deciding on any investment action concerning Jiangsu Hengshun Vinegar-IndustryLtd. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.