It is hard to get excited after looking at Zhejiang Xianju PharmaceuticalLtd's (SZSE:002332) recent performance, when its stock has declined 6.4% 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 Zhejiang Xianju PharmaceuticalLtd'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

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 Zhejiang Xianju PharmaceuticalLtd is:

9.9% = CN¥589m ÷ CN¥6.0b (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.10 in profit.

What Has ROE Got To Do With 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. 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.

Zhejiang Xianju PharmaceuticalLtd's Earnings Growth And 9.9% ROE

At first glance, Zhejiang Xianju PharmaceuticalLtd's ROE doesn't look very promising. However, the fact that the company's ROE is higher than the average industry ROE of 7.5%, is definitely interesting. Consequently, this likely laid the ground for the decent growth of 13% seen over the past five years by Zhejiang Xianju PharmaceuticalLtd. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. So there might well be other reasons for the earnings to grow. E.g the company has a low payout ratio or could belong to a high growth industry.

We then compared Zhejiang Xianju 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. If you're wondering about Zhejiang Xianju PharmaceuticalLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Zhejiang Xianju PharmaceuticalLtd Efficiently Re-investing Its Profits?

Zhejiang Xianju PharmaceuticalLtd has a three-year median payout ratio of 25%, which implies that it retains the remaining 75% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Moreover, Zhejiang Xianju PharmaceuticalLtd is determined to keep sharing its profits with shareholders which we infer from its long history of nine years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 34% over the next three years. Regardless, the future ROE for Zhejiang Xianju PharmaceuticalLtd is speculated to rise to 12% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.

Conclusion

On the whole, we feel that Zhejiang Xianju PharmaceuticalLtd's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.