PharmaResources (Shanghai) (SZSE:301230) has had a rough three months with its share price down 24%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to PharmaResources (Shanghai)'s ROE today.

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 PharmaResources (Shanghai) is:

2.4% = CN¥26m ÷ CN¥1.1b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.02 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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 PharmaResources (Shanghai)'s Earnings Growth And 2.4% ROE

As you can see, PharmaResources (Shanghai)'s ROE looks pretty weak. Even compared to the average industry ROE of 7.6%, the company's ROE is quite dismal. PharmaResources (Shanghai) was still able to see a decent net income growth of 10% over the past five years. We reckon that there could be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared PharmaResources (Shanghai)'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 21% in the same period.

Earnings growth is a huge factor in stock valuation. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Is PharmaResources (Shanghai) fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is PharmaResources (Shanghai) Using Its Retained Earnings Effectively?

PharmaResources (Shanghai) has a healthy combination of a moderate three-year median payout ratio of 48% (or a retention ratio of 52%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

While PharmaResources (Shanghai) has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend.

Conclusion

On the whole, we do feel that PharmaResources (Shanghai) has some positive attributes. Namely, its respectable earnings growth, which it achieved due to it retaining most of its profits. However, given the low ROE, investors may not be benefitting from all that reinvestment after all. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.