With its stock down 10% over the past month, it is easy to disregard Hunan Fangsheng Pharmaceutical (SHSE:603998). However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Hunan Fangsheng Pharmaceutical's ROE today.

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.

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 Hunan Fangsheng Pharmaceutical is:

11% = CN¥176m ÷ CN¥1.6b (Based on the trailing twelve months to September 2023).

The 'return' refers to a company's earnings over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.11.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

Hunan Fangsheng Pharmaceutical's Earnings Growth And 11% ROE

At first glance, Hunan Fangsheng Pharmaceutical seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 8.2%. Probably as a result of this, Hunan Fangsheng Pharmaceutical was able to see an impressive net income growth of 35% 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.

Next, on comparing with the industry net income growth, we found that Hunan Fangsheng Pharmaceutical's growth is quite high when compared to the industry average growth of 11% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. 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. Is Hunan Fangsheng Pharmaceutical fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Hunan Fangsheng Pharmaceutical Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 71% (implying that it keeps only 29% of profits) for Hunan Fangsheng Pharmaceutical suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.

Moreover, Hunan Fangsheng Pharmaceutical is determined to keep sharing its profits with shareholders which we infer from its long history of nine years of paying a dividend. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 21% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 16%, over the same period.

Summary

On the whole, we feel that Hunan Fangsheng Pharmaceutical's performance has been quite good. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. 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 company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.