With its stock down 9.8% over the past three months, it is easy to disregard Zhejiang Huakang Pharmaceutical (SHSE:605077). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Zhejiang Huakang Pharmaceutical's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Zhejiang Huakang Pharmaceutical is:

12% = CN¥340m ÷ CN¥2.8b (Based on the trailing twelve months to September 2023).

The 'return' is the profit 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¥0.12 in profit.

What Has ROE Got To Do With 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.

Zhejiang Huakang Pharmaceutical's Earnings Growth And 12% ROE

At first glance, Zhejiang Huakang Pharmaceutical seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 8.5%. This probably laid the ground for Zhejiang Huakang Pharmaceutical's moderate 9.0% net income growth seen over the past five years.

We then compared Zhejiang Huakang 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 7.3% in the same 5-year 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. Is Zhejiang Huakang Pharmaceutical fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Zhejiang Huakang Pharmaceutical Using Its Retained Earnings Effectively?

Zhejiang Huakang Pharmaceutical has a three-year median payout ratio of 38%, which implies that it retains the remaining 62% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Additionally, Zhejiang Huakang Pharmaceutical has paid dividends over a period of three years which means that the company is pretty serious about sharing its profits with shareholders.

Summary

On the whole, we feel that Zhejiang Huakang Pharmaceutical's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial 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. You can see the 2 risks we have identified for Zhejiang Huakang Pharmaceutical by visiting our risks dashboard for free on our platform here.

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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.