Shanghai Pharmaceuticals Holding Co., Ltd's (SHSE:601607) Financials Are Too Obscure To Link With Current Share Price Momentum: What's In Store For the Stock?

Most readers would already be aware that Shanghai Pharmaceuticals Holding's (SHSE:601607) stock increased significantly by 11% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Particularly, we will be paying attention to Shanghai Pharmaceuticals Holding'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Shanghai Pharmaceuticals Holding

How Is ROE Calculated?

ROE 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 Shanghai Pharmaceuticals Holding is:

6.4% = CN¥5.2b ÷ CN¥80b (Based on the trailing twelve months to December 2023).

The 'return' is the amount earned after tax 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¥0.06 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Shanghai Pharmaceuticals Holding's Earnings Growth And 6.4% ROE

On the face of it, Shanghai Pharmaceuticals Holding's ROE is not much to talk about. However, given that the company's ROE is similar to the average industry ROE of 7.9%, we may spare it some thought. Having said that, Shanghai Pharmaceuticals Holding has shown a meagre net income growth of 4.7% over the past five years. Remember, the company's ROE is not particularly great to begin with. So this could also be one of the reasons behind the company's low growth in earnings.

Next, on comparing with the industry net income growth, we found that Shanghai Pharmaceuticals Holding's reported growth was lower than the industry growth of 7.0% 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. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for 601607? You can find out in our latest intrinsic value infographic research report.

Is Shanghai Pharmaceuticals Holding Using Its Retained Earnings Effectively?

While Shanghai Pharmaceuticals Holding has a decent three-year median payout ratio of 28% (or a retention ratio of 72%), it has seen very little growth in earnings. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Moreover, Shanghai Pharmaceuticals Holding 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. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 37% over the next three years. Still, forecasts suggest that Shanghai Pharmaceuticals Holding's future ROE will rise to 9.3% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.

Conclusion

Overall, we have mixed feelings about Shanghai Pharmaceuticals Holding. 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. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.