Tasly Pharmaceutical Group's (SHSE:600535) stock is up by 3.3% over the past three months. However, the company's financials look a bit inconsistent and market outcomes are ultimately driven by long-term fundamentals, meaning that the stock could head in either direction. In this article, we decided to focus on Tasly Pharmaceutical Group's 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?

ROE 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 Tasly Pharmaceutical Group is:

6.5% = CN¥845m ÷ CN¥13b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.06 in profit.

Why Is ROE Important For 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.

Tasly Pharmaceutical Group's Earnings Growth And 6.5% ROE

At first glance, Tasly Pharmaceutical Group's ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.7%. But Tasly Pharmaceutical Group saw a five year net income decline of 5.6% over the past five years. Remember, the company's ROE is a bit low to begin with. Therefore, the decline in earnings could also be the result of this.

So, as a next step, we compared Tasly Pharmaceutical Group's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 9.1% over the last few years.

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 Tasly Pharmaceutical Group is trading on a high P/E or a low P/E, relative to its industry.

Is Tasly Pharmaceutical Group Efficiently Re-investing Its Profits?

Despite having a normal three-year median payout ratio of 46% (where it is retaining 54% of its profits), Tasly Pharmaceutical Group has seen a decline in earnings as we saw above. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Moreover, Tasly Pharmaceutical Group has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

On the whole, we feel that the performance shown by Tasly Pharmaceutical Group can be open to many interpretations. 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. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.