With its stock down 5.2% over the past week, it is easy to disregard Guobang Pharma (SHSE:605507). We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Stock prices are usually driven by a company's financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Particularly, we will be paying attention to Guobang Pharma's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How To Calculate Return On Equity?

Return on equity 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:

8.1% = CN¥614m ÷ CN¥7.6b (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.08.

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.

A Side By Side comparison of Guobang Pharma's Earnings Growth And 8.1% ROE

When you first look at it, Guobang Pharma's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.6%. On the other hand, Guobang Pharma reported a fairly low 4.8% net income growth over the past five years. Remember, the company's ROE is not particularly great to begin with. So this could also be one of the reasons behind the company's low growth in earnings.

Next, on comparing with the industry net income growth, we found that Guobang Pharma's reported growth was lower than the industry growth of 9.2% over the last few years, which is not something we like to see.

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. Doing so will help them establish if the stock's future looks promising or ominous. 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 Guobang Pharma is trading on a high P/E or a low P/E, relative to its industry.

Is Guobang Pharma Using Its Retained Earnings Effectively?

Despite having a moderate three-year median payout ratio of 37% (implying that the company retains the remaining 63% of its income), Guobang Pharma's earnings growth was quite low. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

In addition, Guobang Pharma has been paying dividends over a period of three years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Conclusion

In total, we're a bit ambivalent about Guobang Pharma's performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com