Tonghua Dongbao Pharmaceutical (SHSE:600867) has had a great run on the share market with its stock up by a significant 25% over the last three months. Since the market usually pay for a company's long-term fundamentals, we decided to study the company's key performance indicators to see if they could be influencing the market. In this article, we decided to focus on Tonghua Dongbao Pharmaceutical's ROE.

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.

View our latest analysis for Tonghua Dongbao Pharmaceutical

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 Tonghua Dongbao Pharmaceutical is:

25% = CN¥1.6b ÷ CN¥6.4b (Based on the trailing twelve months to December 2022).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.25 in profit.

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. 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.

Tonghua Dongbao Pharmaceutical's Earnings Growth And 25% ROE

To begin with, Tonghua Dongbao Pharmaceutical has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 8.4% the company's ROE is quite impressive. Probably as a result of this, Tonghua Dongbao Pharmaceutical was able to see a decent net income growth of 16% over the last five years.

Next, on comparing with the industry net income growth, we found that Tonghua Dongbao Pharmaceutical's growth is quite high when compared to the industry average growth of 9.1% in the same period, which is great to see.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Tonghua Dongbao Pharmaceutical fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Tonghua Dongbao Pharmaceutical Using Its Retained Earnings Effectively?

Tonghua Dongbao Pharmaceutical has a three-year median payout ratio of 47%, which implies that it retains the remaining 53% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Additionally, Tonghua Dongbao Pharmaceutical has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 34% over the next three years. Still forecasts suggest that Tonghua Dongbao Pharmaceutical's future ROE will drop to 16% even though the the company's payout ratio is expected to decrease. This suggests that there could be other factors could driving the anticipated decline in the company's ROE.

Summary

Overall, we are quite pleased with Tonghua Dongbao Pharmaceutical's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.