Henan Lingrui Pharmaceutical's (SHSE:600285) stock is up by a considerable 16% 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. In this article, we decided to focus on Henan Lingrui Pharmaceutical's ROE.

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?

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 Henan Lingrui Pharmaceutical is:

19% = CN¥526m ÷ CN¥2.7b (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.19 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Henan Lingrui Pharmaceutical's Earnings Growth And 19% ROE

To start with, Henan Lingrui Pharmaceutical's ROE looks acceptable. Especially when compared to the industry average of 8.5% the company's ROE looks pretty impressive. This probably laid the ground for Henan Lingrui Pharmaceutical's moderate 16% net income growth seen over the past five years.

As a next step, we compared Henan Lingrui Pharmaceutical's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 11%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Henan Lingrui Pharmaceutical's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Henan Lingrui Pharmaceutical Efficiently Re-investing Its Profits?

While Henan Lingrui Pharmaceutical has a three-year median payout ratio of 66% (which means it retains 34% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.

Additionally, Henan Lingrui 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.

Conclusion

Overall, we are quite pleased with Henan Lingrui Pharmaceutical's performance. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. 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.