Most readers would already be aware that LanZhou Foci PharmaceuticalLtd's (SZSE:002644) stock increased significantly by 14% over the past week. 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. Specifically, we decided to study LanZhou Foci PharmaceuticalLtd'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How Is ROE Calculated?

Return on equity 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 LanZhou Foci PharmaceuticalLtd is:

3.5% = CN¥63m ÷ CN¥1.8b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.04 in profit.

Why Is ROE Important For 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 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.

LanZhou Foci PharmaceuticalLtd's Earnings Growth And 3.5% ROE

It is quite clear that LanZhou Foci PharmaceuticalLtd's ROE is rather low. Even when compared to the industry average of 7.6%, the ROE figure is pretty disappointing. As a result, LanZhou Foci PharmaceuticalLtd's flat earnings over the past five years doesn't come as a surprise given its lower ROE.

As a next step, we compared LanZhou Foci PharmaceuticalLtd'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 9.2% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. If you're wondering about LanZhou Foci PharmaceuticalLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is LanZhou Foci PharmaceuticalLtd Efficiently Re-investing Its Profits?

LanZhou Foci PharmaceuticalLtd's low three-year median payout ratio of 23% (implying that the company keeps77% of its income) should mean that the company is retaining most of its earnings to fuel its growth and this should be reflected in its growth number, but that's not the case.

Additionally, LanZhou Foci PharmaceuticalLtd 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.

Conclusion

In total, we're a bit ambivalent about LanZhou Foci PharmaceuticalLtd's performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. So far, we've only made a quick discussion around the company's earnings growth. To gain further insights into LanZhou Foci PharmaceuticalLtd's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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.

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