Most readers would already be aware that Chengdu Kanghua Biological Products' (SZSE:300841) stock increased significantly by 23% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Chengdu Kanghua Biological Products' ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

How Do You 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 Chengdu Kanghua Biological Products is:

16% = CN¥546m ÷ CN¥3.5b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.16 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. 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. 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.

Chengdu Kanghua Biological Products' Earnings Growth And 16% ROE

At first glance, Chengdu Kanghua Biological Products seems to have a decent ROE. On comparing with the average industry ROE of 6.0% the company's ROE looks pretty remarkable. Probably as a result of this, Chengdu Kanghua Biological Products was able to see a decent growth of 14% over the last five years.

We then compared Chengdu Kanghua Biological Products' 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 5.9% 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). Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for 300841? You can find out in our latest intrinsic value infographic research report.

Is Chengdu Kanghua Biological Products Making Efficient Use Of Its Profits?

In Chengdu Kanghua Biological Products' case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 16% (or a retention ratio of 84%), which suggests that the company is investing most of its profits to grow its business.

Moreover, Chengdu Kanghua Biological Products is determined to keep sharing its profits with shareholders which we infer from its long history of four years of paying a dividend.

Conclusion

In total, we are pretty happy with Chengdu Kanghua Biological Products' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.