With its stock down 20% over the past three months, it is easy to disregard Huaren Pharmaceutical (SZSE:300110). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Huaren Pharmaceutical's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Is ROE Calculated?

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 Huaren Pharmaceutical is:

7.2% = CN¥196m ÷ CN¥2.7b (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.07 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Huaren Pharmaceutical's Earnings Growth And 7.2% ROE

When you first look at it, Huaren Pharmaceutical's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 8.2%. Moreover, we are quite pleased to see that Huaren Pharmaceutical's net income grew significantly at a rate of 34% over the last five years. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Huaren Pharmaceutical's growth is quite high when compared to the industry average growth of 11% 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. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is Huaren Pharmaceutical fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Huaren Pharmaceutical Efficiently Re-investing Its Profits?

Huaren Pharmaceutical's ' three-year median payout ratio is on the lower side at 16% implying that it is retaining a higher percentage (84%) of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Besides, Huaren 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.

Conclusion

In total, it does look like Huaren Pharmaceutical has some positive aspects to its business. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. 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 Huaren 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.