With its stock down 19% over the past three months, it is easy to disregard Shenzhen YHLO Biotech (SHSE:688575). 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. Specifically, we decided to study Shenzhen YHLO Biotech'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 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 Shenzhen YHLO Biotech is:

10% = CN¥267m ÷ CN¥2.6b (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made 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.

Shenzhen YHLO Biotech's Earnings Growth And 10% ROE

When you first look at it, Shenzhen YHLO Biotech's ROE doesn't look that attractive. Although a closer study shows that the company's ROE is higher than the industry average of 7.4% which we definitely can't overlook. Even more so after seeing Shenzhen YHLO Biotech's exceptional 24% net income growth over the past five years. That being said, the company does have a slightly low ROE to begin with, just that it is higher than the industry average. Hence, there might be some other aspects that are causing earnings to grow. For example, it is possible that the broader industry is going through a high growth phase, or that the company has a low payout ratio.

As a next step, we compared Shenzhen YHLO Biotech'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 6.5%.

Earnings growth is an important metric to consider when valuing a stock. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Shenzhen YHLO Biotech is trading on a high P/E or a low P/E, relative to its industry.

Is Shenzhen YHLO Biotech Making Efficient Use Of Its Profits?

The three-year median payout ratio for Shenzhen YHLO Biotech is 44%, which is moderately low. The company is retaining the remaining 56%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Shenzhen YHLO Biotech is reinvesting its earnings efficiently.

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

Conclusion

In total, we are pretty happy with Shenzhen YHLO Biotech's performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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.

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