Most readers would already be aware that Sichuan Huiyu Pharmaceutical's (SHSE:688553) stock increased significantly by 26% over the past month. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. In this article, we decided to focus on Sichuan Huiyu Pharmaceutical's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How Is ROE Calculated?

ROE 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 Sichuan Huiyu Pharmaceutical is:

3.6% = CN¥134m ÷ CN¥3.7b (Based on the trailing twelve months to December 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¥0.04 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. 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. 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.

Sichuan Huiyu Pharmaceutical's Earnings Growth And 3.6% ROE

As you can see, Sichuan Huiyu Pharmaceutical's ROE looks pretty weak. Even compared to the average industry ROE of 8.3%, the company's ROE is quite dismal. Hence, the flat earnings seen by Sichuan Huiyu Pharmaceutical over the past five years could probably be the result of it having a lower ROE.

As a next step, we compared Sichuan Huiyu Pharmaceutical's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 11% in the same period.

Earnings growth is a huge factor in stock valuation. 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. Is Sichuan Huiyu Pharmaceutical fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Sichuan Huiyu Pharmaceutical Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 30% (implying that the company keeps 70% of its income) over the last three years, Sichuan Huiyu Pharmaceutical has seen a negligible amount of growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, Sichuan Huiyu Pharmaceutical started paying a dividend only recently. So it looks like the management must have perceived that shareholders favor dividends over earnings growth.

Summary

In total, we're a bit ambivalent about Sichuan Huiyu Pharmaceutical's performance. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. So far, we've only made a quick discussion around the company's earnings growth. You can do your own research on Sichuan Huiyu Pharmaceutical and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.

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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.