KPC PharmaceuticalsInc's (SHSE:600422) stock is up by 4.3% over the past month. However, the company's financials look a bit inconsistent and market outcomes are ultimately driven by long-term fundamentals, meaning that the stock could head in either direction. In this article, we decided to focus on KPC PharmaceuticalsInc's ROE.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How Do You 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 KPC PharmaceuticalsInc is:

7.4% = CN¥401m ÷ CN¥5.4b (Based on the trailing twelve months to September 2023).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.07 in profit.

What Is The Relationship Between ROE And 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. 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.

A Side By Side comparison of KPC PharmaceuticalsInc's Earnings Growth And 7.4% ROE

When you first look at it, KPC PharmaceuticalsInc's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 8.5%. On the other hand, KPC PharmaceuticalsInc reported a fairly low 2.2% net income growth over the past five years. Remember, the company's ROE is not particularly great to begin with. Hence, this does provide some context to low earnings growth seen by the company.

Next, on comparing with the industry net income growth, we found that KPC PharmaceuticalsInc's reported growth was lower than the industry growth of 11% over the last few years, which is not something we like to see.

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. If you're wondering about KPC PharmaceuticalsInc's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is KPC PharmaceuticalsInc Making Efficient Use Of Its Profits?

Despite having a normal three-year median payout ratio of 32% (or a retention ratio of 68% over the past three years, KPC PharmaceuticalsInc has seen very little growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Moreover, KPC PharmaceuticalsInc has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 17% over the next three years. The fact that the company's ROE is expected to rise to 13% over the same period is explained by the drop in the payout ratio.

Conclusion

Overall, we have mixed feelings about KPC PharmaceuticalsInc. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. 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.