With its stock down 23% over the past three months, it is easy to disregard Zhejiang Hisun Pharmaceutical (SHSE:600267). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on Zhejiang Hisun 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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Zhejiang Hisun Pharmaceutical

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 Zhejiang Hisun Pharmaceutical is:

6.5% = CN¥490m ÷ CN¥7.5b (Based on the trailing twelve months to June 2022).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.07 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Zhejiang Hisun Pharmaceutical's Earnings Growth And 6.5% ROE

When you first look at it, Zhejiang Hisun Pharmaceutical's ROE doesn't look that attractive. However, its ROE is similar to the industry average of 8.1%, so we won't completely dismiss the company. Looking at Zhejiang Hisun Pharmaceutical's exceptional 43% five-year net income growth in particular, we are definitely impressed. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Zhejiang Hisun Pharmaceutical's growth is quite high when compared to the industry average growth of 9.0% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Zhejiang Hisun Pharmaceutical is trading on a high P/E or a low P/E, relative to its industry.

Is Zhejiang Hisun Pharmaceutical Using Its Retained Earnings Effectively?

Zhejiang Hisun Pharmaceutical's ' three-year median payout ratio is on the lower side at 12% implying that it is retaining a higher percentage (88%) of its profits. So it looks like Zhejiang Hisun Pharmaceutical is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Moreover, Zhejiang Hisun Pharmaceutical is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Conclusion

On the whole, we do feel that Zhejiang Hisun 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 3 risks we have identified for Zhejiang Hisun 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.