Guobang Pharma's (SHSE:605507) stock is up by a considerable 18% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to Guobang Pharma'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

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 Guobang Pharma is:

8.9% = CN¥701m ÷ CN¥7.8b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.09 in profit.

Why Is ROE Important For 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. 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.

Guobang Pharma's Earnings Growth And 8.9% ROE

When you first look at it, Guobang Pharma's ROE doesn't look that attractive. However, its ROE is similar to the industry average of 7.8%, so we won't completely dismiss the company. On the other hand, Guobang Pharma reported a fairly low 2.4% net income growth over the past five years. Bear in mind, the company's ROE is not very high . Hence, this does provide some context to low earnings growth seen by the company.

As a next step, we compared Guobang Pharma'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 9.1% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 Guobang Pharma is trading on a high P/E or a low P/E, relative to its industry.

Is Guobang Pharma Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 36% (or a retention ratio of 64% over the past three years, Guobang Pharma has seen very little growth in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, Guobang Pharma has paid dividends over a period of three 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 feel that the performance shown by Guobang Pharma can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.