Renhe PharmacyLtd (SZSE:000650) has had a rough three months with its share price down 9.0%. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Particularly, we will be paying attention to Renhe PharmacyLtd's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. Put another way, it reveals the company's success at turning shareholder investments into profits.

How Do You Calculate Return On Equity?

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 Renhe PharmacyLtd is:

8.7% = CN¥614m ÷ CN¥7.0b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.09 in profit.

What Has ROE Got To Do With Earnings Growth?

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

A Side By Side comparison of Renhe PharmacyLtd's Earnings Growth And 8.7% ROE

On the face of it, Renhe PharmacyLtd's ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.6%. On the other hand, Renhe PharmacyLtd reported a fairly low 2.2% net income growth over the past five years. Bear in mind, the company's ROE is not very high . So this could also be one of the reasons behind the company's low growth in earnings.

As a next step, we compared Renhe PharmacyLtd'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 9.0% in the same period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Renhe PharmacyLtd fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Renhe PharmacyLtd Using Its Retained Earnings Effectively?

While Renhe PharmacyLtd has a decent three-year median payout ratio of 43% (or a retention ratio of 57%), it has seen very little growth in earnings. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Moreover, Renhe PharmacyLtd has been paying dividends for nine years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

In total, we're a bit ambivalent about Renhe PharmacyLtd'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. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. Our risks dashboard will have the 1 risk we have identified for Renhe PharmacyLtd.

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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.