Most readers would already be aware that Hebei Yangyuan ZhiHui Beverage's (SHSE:603156) stock increased significantly by 24% over the past three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. Particularly, we will be paying attention to Hebei Yangyuan ZhiHui Beverage's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. Put another way, it reveals the company's success at turning shareholder investments into profits.

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Hebei Yangyuan ZhiHui Beverage is:

17% = CN¥1.8b ÷ CN¥11b (Based on the trailing twelve months to September 2023).

The 'return' refers to a company's earnings 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¥0.17 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of Hebei Yangyuan ZhiHui Beverage's Earnings Growth And 17% ROE

To start with, Hebei Yangyuan ZhiHui Beverage's ROE looks acceptable. Especially when compared to the industry average of 8.2% the company's ROE looks pretty impressive. Needless to say, we are quite surprised to see that Hebei Yangyuan ZhiHui Beverage's net income shrunk at a rate of 12% over the past five years. Therefore, there might be some other aspects that could explain this. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

However, when we compared Hebei Yangyuan ZhiHui Beverage's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 6.8% in the same period. This is quite worrisome.

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. This then helps them determine if the stock is placed for a bright or bleak future. Is Hebei Yangyuan ZhiHui Beverage fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Hebei Yangyuan ZhiHui Beverage Using Its Retained Earnings Effectively?

Hebei Yangyuan ZhiHui Beverage's very high three-year median payout ratio of 130% over the last three years suggests that the company is paying its shareholders more than what it is earning and this explains the company's shrinking earnings. Paying a dividend beyond their means is usually not viable over the long term. You can see the 2 risks we have identified for Hebei Yangyuan ZhiHui Beverage by visiting our risks dashboard for free on our platform here.

In addition, Hebei Yangyuan ZhiHui Beverage has been paying dividends over a period of six years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.

Conclusion

On the whole, we feel that the performance shown by Hebei Yangyuan ZhiHui Beverage can be open to many interpretations. Despite the high ROE, the company has a disappointing earnings growth number, due to its poor rate of reinvestment into its business. So far, we've only made a quick discussion around the company's earnings growth. So it may be worth checking this free detailed graph of Hebei Yangyuan ZhiHui Beverage's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.