Zhejiang Medicine Co., Ltd. (SHSE:600216) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?

Zhejiang Medicine (SHSE:600216) has had a great run on the share market with its stock up by a significant 57% over the last three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to Zhejiang Medicine's ROE today.

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.

See our latest analysis for Zhejiang Medicine

How To 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 Zhejiang Medicine is:

3.4% = CN¥345m ÷ CN¥10b (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned 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¥0.03 in profit.

Why Is ROE Important For 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. 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.

Zhejiang Medicine's Earnings Growth And 3.4% ROE

As you can see, Zhejiang Medicine's ROE looks pretty weak. Not just that, even compared to the industry average of 7.6%, the company's ROE is entirely unremarkable. Accordingly, Zhejiang Medicine's low net income growth of 3.3% over the past five years can possibly be explained by the low ROE amongst other factors.

Next, on comparing with the industry net income growth, we found that Zhejiang Medicine's reported growth was lower than the industry growth of 9.0% over the last few years, which is not something we like to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Zhejiang Medicine's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Zhejiang Medicine Making Efficient Use Of Its Profits?

While Zhejiang Medicine has a decent three-year median payout ratio of 34% (or a retention ratio of 66%), it has seen very little growth in earnings. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, Zhejiang Medicine has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 19% over the next three years. As a result, the expected drop in Zhejiang Medicine's payout ratio explains the anticipated rise in the company's future ROE to 9.8%, over the same period.

Summary

Overall, we have mixed feelings about Zhejiang Medicine. 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. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.