Are Guangzhou LBP Medicine Science & Technology Co., Ltd.'s (SHSE:688393) Mixed Financials Driving The Negative Sentiment?

Guangzhou LBP Medicine Science & Technology (SHSE:688393) has had a rough month with its share price down 22%. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. In this article, we decided to focus on Guangzhou LBP Medicine Science & Technology's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Guangzhou LBP Medicine Science & Technology

How To Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for Guangzhou LBP Medicine Science & Technology is:

2.0% = CN¥25m ÷ CN¥1.2b (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.02 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. 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.

Guangzhou LBP Medicine Science & Technology's Earnings Growth And 2.0% ROE

It is hard to argue that Guangzhou LBP Medicine Science & Technology's ROE is much good in and of itself. Not just that, even compared to the industry average of 7.4%, the company's ROE is entirely unremarkable. Therefore, it might not be wrong to say that the five year net income decline of 21% seen by Guangzhou LBP Medicine Science & Technology was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

That being said, we compared Guangzhou LBP Medicine Science & Technology's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 6.5% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. 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. 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 Guangzhou LBP Medicine Science & Technology is trading on a high P/E or a low P/E, relative to its industry.

Is Guangzhou LBP Medicine Science & Technology Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 35% (that is, a retention ratio of 65%), the fact that Guangzhou LBP Medicine Science & Technology's earnings have shrunk is quite puzzling. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Moreover, Guangzhou LBP Medicine Science & Technology has been paying dividends for three years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking.

Conclusion

Overall, we have mixed feelings about Guangzhou LBP Medicine Science & Technology. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. To know the 2 risks we have identified for Guangzhou LBP Medicine Science & Technology 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.