It is hard to get excited after looking at Hunan Warrant PharmaceuticalLtd's (SHSE:688799) recent performance, when its stock has declined 21% over the past three months. However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Hunan Warrant PharmaceuticalLtd'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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

How To 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 Hunan Warrant PharmaceuticalLtd is:

11% = CN¥201m ÷ CN¥1.8b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.11 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company's earnings growth potential. 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.

Hunan Warrant PharmaceuticalLtd's Earnings Growth And 11% ROE

To start with, Hunan Warrant PharmaceuticalLtd's ROE looks acceptable. On comparing with the average industry ROE of 7.6% the company's ROE looks pretty remarkable. This probably laid the ground for Hunan Warrant PharmaceuticalLtd's moderate 14% net income growth seen over the past five years.

We then compared Hunan Warrant PharmaceuticalLtd's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 9.2% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. 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 Hunan Warrant PharmaceuticalLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Hunan Warrant PharmaceuticalLtd Efficiently Re-investing Its Profits?

With a three-year median payout ratio of 38% (implying that the company retains 62% of its profits), it seems that Hunan Warrant PharmaceuticalLtd is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

While Hunan Warrant PharmaceuticalLtd has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend.

Summary

On the whole, we feel that Hunan Warrant PharmaceuticalLtd's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. 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. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. You can see the 1 risk we have identified for Hunan Warrant PharmaceuticalLtd by visiting our risks dashboard for free on our platform here.

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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.

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