PhiChem's (SZSE:300398) stock is up by a considerable 9.3% over the past month. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Particularly, we will be paying attention to PhiChem's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company's success at turning shareholder investments into profits.

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 PhiChem is:

2.1% = CN¥87m ÷ CN¥4.1b (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.02.

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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

PhiChem's Earnings Growth And 2.1% ROE

It is quite clear that PhiChem's ROE is rather low. Even when compared to the industry average of 6.4%, the ROE figure is pretty disappointing. Therefore, PhiChem's flat earnings over the past five years can possibly be explained by the low ROE amongst other factors.

We then compared PhiChem's net income growth with the industry and found that the average industry growth rate was 6.2% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Is PhiChem fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is PhiChem Making Efficient Use Of Its Profits?

PhiChem has a low three-year median payout ratio of 11% (or a retention ratio of 89%) but the negligible earnings growth number doesn't reflect this as high growth usually follows high profit retention.

In addition, PhiChem has been paying dividends over a period of nine years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Conclusion

Overall, we have mixed feelings about PhiChem. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.