It is hard to get excited after looking at Shijiazhuang Yiling Pharmaceutical's (SZSE:002603) recent performance, when its stock has declined 13% over the past three months. 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 Shijiazhuang Yiling 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 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?

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 Shijiazhuang Yiling Pharmaceutical is:

23% = CN¥2.7b ÷ CN¥12b (Based on the trailing twelve months to September 2023).

The 'return' is the profit over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.23 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Shijiazhuang Yiling Pharmaceutical's Earnings Growth And 23% ROE

At first glance, Shijiazhuang Yiling Pharmaceutical seems to have a decent ROE. On comparing with the average industry ROE of 8.2% the company's ROE looks pretty remarkable. Probably as a result of this, Shijiazhuang Yiling Pharmaceutical was able to see an impressive net income growth of 34% over the last five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

We then compared Shijiazhuang Yiling Pharmaceutical's 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 11% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. 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. 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 Shijiazhuang Yiling Pharmaceutical is trading on a high P/E or a low P/E, relative to its industry.

Is Shijiazhuang Yiling Pharmaceutical Efficiently Re-investing Its Profits?

Shijiazhuang Yiling Pharmaceutical has a three-year median payout ratio of 35% (where it is retaining 65% of its income) which is not too low or not too high. By the looks of it, the dividend is well covered and Shijiazhuang Yiling Pharmaceutical is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Besides, Shijiazhuang Yiling 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 31% of its profits over the next three years. Regardless, Shijiazhuang Yiling Pharmaceutical's ROE is speculated to decline to 17% despite there being no anticipated change in its payout ratio.

Conclusion

In total, we are pretty happy with Shijiazhuang Yiling Pharmaceutical's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.