Most readers would already be aware that Anhui Fengyuan Pharmaceutical's (SZSE:000153) stock increased significantly by 21% over the past week. 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. Particularly, we will be paying attention to Anhui Fengyuan Pharmaceutical's ROE today.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

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 Anhui Fengyuan Pharmaceutical is:

7.8% = CN¥154m ÷ CN¥2.0b (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 Is The Relationship Between ROE And 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 Anhui Fengyuan Pharmaceutical's Earnings Growth And 7.8% ROE

When you first look at it, Anhui Fengyuan Pharmaceutical's ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 7.6%, we may spare it some thought. On the other hand, Anhui Fengyuan Pharmaceutical reported a moderate 17% net income growth over the past five years. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Anhui Fengyuan Pharmaceutical'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 9.0%.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Anhui Fengyuan Pharmaceutical fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Anhui Fengyuan Pharmaceutical Efficiently Re-investing Its Profits?

In Anhui Fengyuan Pharmaceutical's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 21% (or a retention ratio of 79%), which suggests that the company is investing most of its profits to grow its business.

Besides, Anhui Fengyuan Pharmaceutical has been paying dividends over a period of eight years. This shows that the company is committed to sharing profits with its shareholders.

Conclusion

On the whole, we do feel that Anhui Fengyuan Pharmaceutical has some positive attributes. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. 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. Our risks dashboard would have the 2 risks we have identified for Anhui Fengyuan Pharmaceutical.

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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.