Shanghai Shenqi Pharmaceutical Investment Management (SHSE:600613) has had a rough three months with its share price down 24%. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. In this article, we decided to focus on Shanghai Shenqi Pharmaceutical Investment Management's ROE.

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 Is ROE Calculated?

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 Shenqi Pharmaceutical Investment Management is:

2.4% = CN¥57m ÷ CN¥2.4b (Based on the trailing twelve months to September 2023).

The 'return' is the profit 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 Has ROE Got To Do With 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. 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 Shenqi Pharmaceutical Investment Management's Earnings Growth And 2.4% ROE

It is hard to argue that Shanghai Shenqi Pharmaceutical Investment Management's ROE is much good in and of itself. Even when compared to the industry average of 8.5%, the ROE figure is pretty disappointing. Therefore, it might not be wrong to say that the five year net income decline of 9.6% seen by Shanghai Shenqi Pharmaceutical Investment Management was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

So, as a next step, we compared Shanghai Shenqi Pharmaceutical Investment Management'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 11% over the last few years.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Shanghai Shenqi Pharmaceutical Investment Management's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shanghai Shenqi Pharmaceutical Investment Management Using Its Retained Earnings Effectively?

Shanghai Shenqi Pharmaceutical Investment Management's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 91% (or a retention ratio of 8.8%). The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. You can see the 3 risks we have identified for Shanghai Shenqi Pharmaceutical Investment Management by visiting our risks dashboard for free on our platform here.

In addition, Shanghai Shenqi Pharmaceutical Investment Management has been paying dividends over a period of nine years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.

Summary

Overall, we would be extremely cautious before making any decision on Shanghai Shenqi Pharmaceutical Investment Management. The low ROE, combined with the fact that the company is paying out almost if not all, of its profits as dividends, has resulted in the lack or absence of growth in its earnings. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. You can do your own research on Shanghai Shenqi Pharmaceutical Investment Management and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.

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