With its stock down 18% over the past three months, it is easy to disregard CSPC Innovation Pharmaceutical (SZSE:300765). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on CSPC Innovation Pharmaceutical's ROE.

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 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 CSPC Innovation Pharmaceutical is:

11% = CN¥521m ÷ CN¥4.7b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.11 in profit.

What Has ROE Got To Do With 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.

CSPC Innovation Pharmaceutical's Earnings Growth And 11% ROE

To begin with, CSPC Innovation Pharmaceutical seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 7.7%. Probably as a result of this, CSPC Innovation Pharmaceutical was able to see an impressive net income growth of 21% over the last five years. We reckon that there could also be other factors at play here. Such as - high earnings retention or an efficient management in place.

As a next step, we compared CSPC Innovation 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 9.1%.

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. This then helps them determine if the stock is placed for a bright or bleak future. Is 300765 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is CSPC Innovation Pharmaceutical Efficiently Re-investing Its Profits?

CSPC Innovation Pharmaceutical's ' three-year median payout ratio is on the lower side at 18% implying that it is retaining a higher percentage (82%) of its profits. So it looks like CSPC Innovation Pharmaceutical is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Besides, CSPC Innovation Pharmaceutical has been paying dividends over a period of five years. This shows that the company is committed to sharing profits with its shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 23% over the next three years. However, CSPC Innovation Pharmaceutical's future ROE is expected to rise to 13% despite the expected increase in the company's payout ratio. We infer that there could be other factors that could be driving the anticipated growth in the company's ROE.

Conclusion

Overall, we are quite pleased with CSPC Innovation Pharmaceutical's 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. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.