Most readers would already be aware that Star Lake BioscienceZhaoqing Guangdong's (SHSE:600866) stock increased significantly by 79% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on Star Lake BioscienceZhaoqing Guangdong's ROE.

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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Star Lake BioscienceZhaoqing Guangdong is:

10% = CN¥817m ÷ CN¥7.9b (Based on the trailing twelve months to March 2024).

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¥0.10 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

A Side By Side comparison of Star Lake BioscienceZhaoqing Guangdong's Earnings Growth And 10% ROE

At first glance, Star Lake BioscienceZhaoqing Guangdong's ROE doesn't look very promising. Although a closer study shows that the company's ROE is higher than the industry average of 8.1% which we definitely can't overlook. Even more so after seeing Star Lake BioscienceZhaoqing Guangdong's exceptional 43% net income growth over the past five years. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. Hence, there might be some other aspects that are causing earnings to grow. E.g the company has a low payout ratio or could belong to a high growth industry.

Next, on comparing with the industry net income growth, we found that Star Lake BioscienceZhaoqing Guangdong's growth is quite high when compared to the industry average growth of 2.9% in the same period, which is great to see.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Star Lake BioscienceZhaoqing Guangdong is trading on a high P/E or a low P/E, relative to its industry.

Is Star Lake BioscienceZhaoqing Guangdong Making Efficient Use Of Its Profits?

Star Lake BioscienceZhaoqing Guangdong has a significant three-year median payout ratio of 86%, meaning the company only retains 14% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.

Summary

On the whole, we do feel that Star Lake BioscienceZhaoqing Guangdong has some positive attributes. Specifically, its respectable ROE which likely led to the considerable growth in earnings. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.