Shanghai Yizhong Pharmaceutical (SHSE:688091) has had a great run on the share market with its stock up by a significant 12% over the last month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Shanghai Yizhong 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Shanghai Yizhong Pharmaceutical

How Do You 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 Shanghai Yizhong Pharmaceutical is:

12% = CN¥169m ÷ CN¥1.4b (Based on the trailing twelve months to September 2023).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.12 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

Shanghai Yizhong Pharmaceutical's Earnings Growth And 12% ROE

To begin with, Shanghai Yizhong Pharmaceutical seems to have a respectable ROE. Especially when compared to the industry average of 8.5% the company's ROE looks pretty impressive. This probably laid the ground for Shanghai Yizhong Pharmaceutical's significant 85% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

We then compared Shanghai Yizhong 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 11% in the same 5-year 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. 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 Shanghai Yizhong Pharmaceutical is trading on a high P/E or a low P/E, relative to its industry.

Is Shanghai Yizhong Pharmaceutical Using Its Retained Earnings Effectively?

Shanghai Yizhong Pharmaceutical has a three-year median payout ratio of 26% (where it is retaining 74% of its income) which is not too low or not too high. So it seems that Shanghai Yizhong Pharmaceutical is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

While Shanghai Yizhong Pharmaceutical 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.

Summary

In total, we are pretty happy with Shanghai Yizhong Pharmaceutical's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. To know the 3 risks we have identified for Shanghai Yizhong Pharmaceutical visit our risks dashboard for free.

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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.