With its stock down 24% over the past three months, it is easy to disregard Chengdu Kanghua Biological Products (SZSE:300841). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Chengdu Kanghua Biological Products' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Is ROE Calculated?

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 Chengdu Kanghua Biological Products is:

14% = CN¥484m ÷ CN¥3.4b (Based on the trailing twelve months to September 2023).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.14 in profit.

What Has ROE Got To Do With 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 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.

Chengdu Kanghua Biological Products' Earnings Growth And 14% ROE

To start with, Chengdu Kanghua Biological Products' ROE looks acceptable. On comparing with the average industry ROE of 6.6% the company's ROE looks pretty remarkable. Probably as a result of this, Chengdu Kanghua Biological Products was able to see an impressive net income growth of 26% over the last five years. We reckon that there could also be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Chengdu Kanghua Biological Products' 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%.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is 300841 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Chengdu Kanghua Biological Products Efficiently Re-investing Its Profits?

Chengdu Kanghua Biological Products' ' three-year median payout ratio is on the lower side at 15% implying that it is retaining a higher percentage (85%) of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

Besides, Chengdu Kanghua Biological Products has been paying dividends over a period of three years. This shows that the company is committed to sharing profits with its shareholders.

Conclusion

On the whole, we feel that Chengdu Kanghua Biological Products' performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.