ChengDa Pharmaceuticals (SZSE:301201) has had a great run on the share market with its stock up by a significant 32% over the last three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on ChengDa Pharmaceuticals' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How To Calculate Return On Equity?

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 ChengDa Pharmaceuticals is:

4.0% = CN¥91m ÷ CN¥2.3b (Based on the trailing twelve months to December 2023).

The 'return' is the amount earned after tax 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¥0.04 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

A Side By Side comparison of ChengDa Pharmaceuticals' Earnings Growth And 4.0% ROE

It is quite clear that ChengDa Pharmaceuticals' ROE is rather low. Even when compared to the industry average of 7.7%, the ROE figure is pretty disappointing. However, the moderate 12% net income growth seen by ChengDa Pharmaceuticals over the past five years is definitely a positive. Therefore, the growth in earnings could probably have been caused by other variables. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared ChengDa Pharmaceuticals' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 9.2%.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is ChengDa Pharmaceuticals fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is ChengDa Pharmaceuticals Efficiently Re-investing Its Profits?

With a three-year median payout ratio of 33% (implying that the company retains 67% of its profits), it seems that ChengDa Pharmaceuticals is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

While ChengDa Pharmaceuticals has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend.

Conclusion

On the whole, we do feel that ChengDa Pharmaceuticals has some positive attributes. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 2 risks we have identified for ChengDa Pharmaceuticals 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.