Guangdong Zhongsheng Pharmaceutical's (SZSE:002317) stock is up by 7.4% over the past 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 Guangdong Zhongsheng Pharmaceutical'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

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 Guangdong Zhongsheng Pharmaceutical is:

2.3% = CN¥107m ÷ CN¥4.5b (Based on the trailing twelve months to September 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.02 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

A Side By Side comparison of Guangdong Zhongsheng Pharmaceutical's Earnings Growth And 2.3% ROE

As you can see, Guangdong Zhongsheng Pharmaceutical's ROE looks pretty weak. Not just that, even compared to the industry average of 7.8%, the company's ROE is entirely unremarkable. Although, we can see that Guangdong Zhongsheng Pharmaceutical saw a modest net income growth of 10% over the past five years. Therefore, the growth in earnings could probably have been caused by other variables. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Guangdong Zhongsheng Pharmaceutical's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 9.0% in the same 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). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Guangdong Zhongsheng Pharmaceutical's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Guangdong Zhongsheng Pharmaceutical Making Efficient Use Of Its Profits?

Guangdong Zhongsheng Pharmaceutical has a significant three-year median payout ratio of 57%, meaning that it is left with only 43% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Besides, Guangdong Zhongsheng Pharmaceutical has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.

Summary

On the whole, we do feel that Guangdong Zhongsheng Pharmaceutical has some positive attributes. While no doubt its earnings growth is pretty substantial, we do feel that the reinvestment rate is pretty low, meaning, the earnings growth number could have been significantly higher had the company been retaining more of its profits. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.