Shanghai Pharmaceuticals Holding (SHSE:601607) has had a great run on the share market with its stock up by a significant 13% over the last three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. Particularly, we will be paying attention to Shanghai Pharmaceuticals Holding's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How Do You 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 Shanghai Pharmaceuticals Holding is:

6.2% = CN¥5.1b ÷ CN¥82b (Based on the trailing twelve months to March 2024).

The 'return' is the profit over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.06 in profit.

What Has ROE Got To Do With Earnings Growth?

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

Shanghai Pharmaceuticals Holding's Earnings Growth And 6.2% ROE

On the face of it, Shanghai Pharmaceuticals Holding's ROE is not much to talk about. However, given that the company's ROE is similar to the average industry ROE of 6.4%, we may spare it some thought. Having said that, Shanghai Pharmaceuticals Holding has shown a meagre net income growth of 2.8% over the past five years. Remember, the company's ROE is not particularly great to begin with. Hence, this does provide some context to low earnings growth seen by the company.

As a next step, we compared Shanghai Pharmaceuticals Holding'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 4.2% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Shanghai Pharmaceuticals Holding's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shanghai Pharmaceuticals Holding Efficiently Re-investing Its Profits?

Despite having a moderate three-year median payout ratio of 28% (implying that the company retains the remaining 72% of its income), Shanghai Pharmaceuticals Holding's earnings growth was quite low. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

In addition, Shanghai Pharmaceuticals Holding has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 36% over the next three years. However, Shanghai Pharmaceuticals Holding's future ROE is expected to rise to 8.1% despite the expected increase in the company's payout ratio. We infer that there could be other factors that could be driving the anticipated growth in the company's ROE.

Conclusion

In total, we're a bit ambivalent about Shanghai Pharmaceuticals Holding's performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.

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