With its stock down 11% over the past three months, it is easy to disregard Guobang Pharma (SHSE:605507). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study Guobang Pharma's ROE in this article.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How To Calculate Return On Equity?

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 Guobang Pharma is:

9.4% = CN¥687m ÷ CN¥7.3b (Based on the trailing twelve months to September 2023).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.09 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Guobang Pharma's Earnings Growth And 9.4% ROE

When you first look at it, Guobang Pharma's ROE doesn't look that attractive. However, its ROE is similar to the industry average of 8.3%, so we won't completely dismiss the company. Even so, Guobang Pharma has shown a fairly decent growth in its net income which grew at a rate of 17%. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Guobang Pharma'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%.

Earnings growth is a huge factor in stock valuation. 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 605507 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Guobang Pharma Using Its Retained Earnings Effectively?

With a three-year median payout ratio of 43% (implying that the company retains 57% of its profits), it seems that Guobang Pharma is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Along with seeing a growth in earnings, Guobang Pharma only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders.

Conclusion

In total, it does look like Guobang Pharma has some positive aspects to its business. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.