With its stock down 15% over the past three months, it is easy to disregard Shanghai Yizhong Pharmaceutical (SHSE:688091). 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. Particularly, we will be paying attention to Shanghai Yizhong Pharmaceutical's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Shanghai Yizhong Pharmaceutical

How To Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Shanghai Yizhong Pharmaceutical is:

12% = CN¥167m ÷ CN¥1.4b (Based on the trailing twelve months to March 2023).

The 'return' is the yearly profit. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.12.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Shanghai Yizhong Pharmaceutical's Earnings Growth And 12% ROE

To start with, Shanghai Yizhong Pharmaceutical's ROE looks acceptable. Especially when compared to the industry average of 8.8% the company's ROE looks pretty impressive. Probably as a result of this, Shanghai Yizhong Pharmaceutical was able to see an impressive net income growth of 91% over the last five years. However, there could also be other causes behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared Shanghai Yizhong 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 8.8% 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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Shanghai Yizhong Pharmaceutical is trading on a high P/E or a low P/E, relative to its industry.

Is Shanghai Yizhong Pharmaceutical Efficiently Re-investing Its Profits?

The three-year median payout ratio for Shanghai Yizhong Pharmaceutical is 28%, which is moderately low. The company is retaining the remaining 72%. By the looks of it, the dividend is well covered and Shanghai Yizhong Pharmaceutical is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Conclusion

Overall, we are quite pleased with Shanghai Yizhong 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. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. To know the 2 risks we have identified for Shanghai Yizhong Pharmaceutical visit our risks dashboard for free.

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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.