Most readers would already be aware that Innovita Biological Technology's (SHSE:688253) stock increased significantly by 47% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Innovita Biological Technology's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. 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 return on equity is:

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

So, based on the above formula, the ROE for Innovita Biological Technology is:

10% = CN¥175m ÷ CN¥1.7b (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.10 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. 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 Innovita Biological Technology's Earnings Growth And 10% ROE

On the face of it, Innovita Biological Technology's ROE is not much to talk about. However, given that the company's ROE is similar to the average industry ROE of 10.0%, we may spare it some thought. On the other hand, Innovita Biological Technology reported a moderate 5.7% net income growth over the past five years. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Innovita Biological Technology's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 15% in the same period.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Innovita Biological Technology is trading on a high P/E or a low P/E, relative to its industry.

Is Innovita Biological Technology Using Its Retained Earnings Effectively?

Innovita Biological Technology has a low three-year median payout ratio of 14%, meaning that the company retains the remaining 86% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Along with seeing a growth in earnings, Innovita Biological Technology only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders.

Summary

In total, it does look like Innovita Biological Technology has some positive aspects to its business. That is, a decent growth in earnings backed by a high rate of reinvestment. However, we do feel that that earnings growth could have been higher if the business were to improve on the low ROE rate. Especially given how the company is reinvesting a huge chunk of its profits.

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.