Jiangsu Nhwa Pharmaceutical (SZSE:002262) has had a great run on the share market with its stock up by a significant 12% over the last month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Jiangsu Nhwa Pharmaceutical's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. 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?

The formula for ROE is:

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

So, based on the above formula, the ROE for Jiangsu Nhwa Pharmaceutical is:

16% = CN¥1.1b ÷ CN¥6.7b (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.16 in profit.

What Is The Relationship Between ROE And Earnings Growth?

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

Jiangsu Nhwa Pharmaceutical's Earnings Growth And 16% ROE

To start with, Jiangsu Nhwa Pharmaceutical's ROE looks acceptable. On comparing with the average industry ROE of 7.7% the company's ROE looks pretty remarkable. This certainly adds some context to Jiangsu Nhwa Pharmaceutical's decent 12% net income growth seen over the past five years.

We then compared Jiangsu Nhwa 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 9.1% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. 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 Jiangsu Nhwa Pharmaceutical is trading on a high P/E or a low P/E, relative to its industry.

Is Jiangsu Nhwa Pharmaceutical Making Efficient Use Of Its Profits?

Jiangsu Nhwa Pharmaceutical has a low three-year median payout ratio of 22%, meaning that the company retains the remaining 78% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Moreover, Jiangsu Nhwa 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 14% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.

Summary

In total, we are pretty happy with Jiangsu Nhwa 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. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.