Most readers would already be aware that Tonghua Golden-Horse Pharmaceutical Industry CoLtd's (SZSE:000766) stock increased significantly by 5.3% over the past week. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Tonghua Golden-Horse Pharmaceutical Industry CoLtd'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

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 Tonghua Golden-Horse Pharmaceutical Industry CoLtd is:

1.9% = CN¥43m ÷ CN¥2.3b (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.02 in profit.

What Is The Relationship Between ROE And 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. 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.

Tonghua Golden-Horse Pharmaceutical Industry CoLtd's Earnings Growth And 1.9% ROE

It is quite clear that Tonghua Golden-Horse Pharmaceutical Industry CoLtd's ROE is rather low. Not just that, even compared to the industry average of 7.7%, the company's ROE is entirely unremarkable. However, we we're pleasantly surprised to see that Tonghua Golden-Horse Pharmaceutical Industry CoLtd grew its net income at a significant rate of 29% in the last five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

Next, on comparing with the industry net income growth, we found that Tonghua Golden-Horse Pharmaceutical Industry CoLtd's growth is quite high when compared to the industry average growth of 9.2% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Tonghua Golden-Horse Pharmaceutical Industry CoLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Tonghua Golden-Horse Pharmaceutical Industry CoLtd Using Its Retained Earnings Effectively?

Tonghua Golden-Horse Pharmaceutical Industry CoLtd doesn't pay any regular dividends currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the high earnings growth number that we discussed above.

Summary

In total, it does look like Tonghua Golden-Horse Pharmaceutical Industry CoLtd has some positive aspects to its business. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. 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. Our risks dashboard will have the 1 risk we have identified for Tonghua Golden-Horse Pharmaceutical Industry CoLtd.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com