It is hard to get excited after looking at HPGC Renmintongtai Pharmaceutical's (SHSE:600829) recent performance, when its stock has declined 24% over the past three months. 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 HPGC Renmintongtai Pharmaceutical'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

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 HPGC Renmintongtai Pharmaceutical is:

11% = CN¥292m ÷ CN¥2.8b (Based on the trailing twelve months to December 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¥0.11 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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company's earnings growth potential. 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.

HPGC Renmintongtai Pharmaceutical's Earnings Growth And 11% ROE

At first glance, HPGC Renmintongtai Pharmaceutical's ROE doesn't look very promising. Although a closer study shows that the company's ROE is higher than the industry average of 7.9% which we definitely can't overlook. Still, HPGC Renmintongtai Pharmaceutical's net income growth of 4.3% over the past five years was mediocre at best. Bear in mind, the company does have a low ROE. It is just that the industry ROE is lower. So that could be one of the factors that are causing earnings growth to stay low.

We then compared HPGC Renmintongtai Pharmaceutical's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 7.0% in the same 5-year period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. 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 HPGC Renmintongtai Pharmaceutical is trading on a high P/E or a low P/E, relative to its industry.

Is HPGC Renmintongtai Pharmaceutical Efficiently Re-investing Its Profits?

Despite having a normal three-year median payout ratio of 35% (or a retention ratio of 65% over the past three years, HPGC Renmintongtai Pharmaceutical has seen very little growth in earnings as we saw above. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, HPGC Renmintongtai Pharmaceutical 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.

Summary

On the whole, we do feel that HPGC Renmintongtai Pharmaceutical has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a moderate ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the 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 will have the 1 risk we have identified for HPGC Renmintongtai Pharmaceutical.

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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.