Most readers would already be aware that Jiangsu Lianhuan Pharmaceutical's (SHSE:600513) stock increased significantly by 25% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Jiangsu Lianhuan Pharmaceutical's ROE today.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How To Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Jiangsu Lianhuan Pharmaceutical is:

10% = CN¥158m ÷ CN¥1.6b (Based on the trailing twelve months to September 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¥0.10 in profit.

What Is The Relationship Between ROE And 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.

Jiangsu Lianhuan Pharmaceutical's Earnings Growth And 10% ROE

When you first look at it, Jiangsu Lianhuan Pharmaceutical's ROE doesn't look that attractive. However, the fact that the company's ROE is higher than the average industry ROE of 7.7%, is definitely interesting. Consequently, this likely laid the ground for the decent growth of 11% seen over the past five years by Jiangsu Lianhuan Pharmaceutical. That being said, the company does have a slightly low ROE to begin with, just that it is higher than the industry average. Therefore, the growth in earnings could also be the result of other factors. For example, it is possible that the broader industry is going through a high growth phase, or that the company has a low payout ratio.

Next, on comparing with the industry net income growth, we found that Jiangsu Lianhuan Pharmaceutical's growth is quite high when compared to the industry average growth of 9.0% 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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Jiangsu Lianhuan Pharmaceutical's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Jiangsu Lianhuan Pharmaceutical Making Efficient Use Of Its Profits?

Jiangsu Lianhuan Pharmaceutical has a healthy combination of a moderate three-year median payout ratio of 31% (or a retention ratio of 69%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Additionally, Jiangsu Lianhuan Pharmaceutical has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders.

Summary

On the whole, we feel that Jiangsu Lianhuan Pharmaceutical's performance has been quite good. In particular, it's great to see that the company has seen significant growth in its earnings backed by a respectable ROE and a high reinvestment rate. 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. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. Our risks dashboard will have the 1 risk we have identified for Jiangsu Lianhuan Pharmaceutical.

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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.