Northeast Pharmaceutical Group (SZSE:000597) has had a great run on the share market with its stock up by a significant 14% over the last three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Northeast Pharmaceutical Group's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

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 Northeast Pharmaceutical Group is:

7.6% = CN¥398m ÷ CN¥5.2b (Based on the trailing twelve months to June 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?

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.

Northeast Pharmaceutical Group's Earnings Growth And 7.6% ROE

At first glance, Northeast Pharmaceutical Group's ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 7.6%, we may spare it some thought. Moreover, we are quite pleased to see that Northeast Pharmaceutical Group's net income grew significantly at a rate of 33% over the last five years. 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.

We then compared Northeast Pharmaceutical Group's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 9.0% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for 000597? You can find out in our latest intrinsic value infographic research report

Is Northeast Pharmaceutical Group Using Its Retained Earnings Effectively?

Northeast Pharmaceutical Group has a three-year median payout ratio of 38% (where it is retaining 62% of its income) which is not too low or not too high. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Northeast Pharmaceutical Group is reinvesting its earnings efficiently.

Additionally, Northeast Pharmaceutical Group has paid dividends over a period of three years which means that the company is pretty serious about sharing its profits with shareholders.

Conclusion

Overall, we feel that Northeast Pharmaceutical Group certainly does have some positive factors to consider. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 3 risks we have identified for Northeast Pharmaceutical Group visit our risks dashboard for free.

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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.