It is hard to get excited after looking at Jiangsu Lianhuan Pharmaceutical's (SHSE:600513) recent performance, when its stock has declined 23% over the past month. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Jiangsu Lianhuan 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

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 Jiangsu Lianhuan Pharmaceutical is:

10.0% = CN¥147m ÷ CN¥1.5b (Based on the trailing twelve months to September 2023).

The 'return' refers to a company's earnings over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.10 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. 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.

Jiangsu Lianhuan Pharmaceutical's Earnings Growth And 10.0% ROE

When you first look at it, Jiangsu Lianhuan Pharmaceutical's ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 8.5%, we may spare it some thought. On the other hand, Jiangsu Lianhuan Pharmaceutical reported a moderate 15% net income growth over the past five years. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's 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.

As a next step, we compared Jiangsu Lianhuan Pharmaceutical's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 11%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Jiangsu Lianhuan Pharmaceutical's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Jiangsu Lianhuan Pharmaceutical Making Efficient Use Of Its Profits?

Jiangsu Lianhuan Pharmaceutical has a healthy combination of a moderate three-year median payout ratio of 29% (or a retention ratio of 71%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Besides, Jiangsu Lianhuan 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.

Summary

On the whole, we do feel that Jiangsu Lianhuan Pharmaceutical has some positive attributes. 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. To know the 2 risks we have identified for Jiangsu Lianhuan 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.