Henan Lingrui Pharmaceutical's (SHSE:600285) stock is up by a considerable 27% over the past three months. Since the market usually pay for a company's long-term fundamentals, we decided to study the company's key performance indicators to see if they could be influencing the market. In this article, we decided to focus on Henan Lingrui Pharmaceutical's ROE.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

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 Henan Lingrui Pharmaceutical is:

21% = CN¥614m ÷ CN¥2.9b (Based on the trailing twelve months to March 2024).

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¥0.21 in profit.

What Has ROE Got To Do With 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. 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.

Henan Lingrui Pharmaceutical's Earnings Growth And 21% ROE

To begin with, Henan Lingrui Pharmaceutical seems to have a respectable ROE. On comparing with the average industry ROE of 7.7% the company's ROE looks pretty remarkable. Probably as a result of this, Henan Lingrui Pharmaceutical was able to see a decent growth of 17% over the last five years.

We then compared Henan Lingrui Pharmaceutical's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 9.2% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is 600285 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Henan Lingrui Pharmaceutical Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 67% (or a retention ratio of 33%) for Henan Lingrui Pharmaceutical suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Moreover, Henan Lingrui Pharmaceutical is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Conclusion

On the whole, we feel that Henan Lingrui Pharmaceutical's performance has been quite good. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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.