Tianjin Tianyao Pharmaceuticals Co., Ltd.'s (SHSE:600488) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

Most readers would already be aware that Tianjin Tianyao Pharmaceuticals' (SHSE:600488) stock increased significantly by 23% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Specifically, we decided to study Tianjin Tianyao Pharmaceuticals' ROE in this article.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Tianjin Tianyao Pharmaceuticals

How Do You Calculate Return On Equity?

Return on equity 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 Tianjin Tianyao Pharmaceuticals is:

4.8% = CN¥185m ÷ CN¥3.8b (Based on the trailing twelve months to June 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¥0.05 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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.

Tianjin Tianyao Pharmaceuticals' Earnings Growth And 4.8% ROE

It is hard to argue that Tianjin Tianyao Pharmaceuticals' ROE is much good in and of itself. Even compared to the average industry ROE of 7.6%, the company's ROE is quite dismal. For this reason, Tianjin Tianyao Pharmaceuticals' five year net income decline of 9.6% is not surprising given its 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 Tianjin Tianyao Pharmaceuticals' 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 9.0% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. If you're wondering about Tianjin Tianyao Pharmaceuticals''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Tianjin Tianyao Pharmaceuticals Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 31% (where it is retaining 69% of its profits), Tianjin Tianyao Pharmaceuticals has seen a decline in earnings as we saw above. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, Tianjin Tianyao Pharmaceuticals 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.

Summary

Overall, we have mixed feelings about Tianjin Tianyao Pharmaceuticals. While the company does have a high rate of profit retention, its low rate of return is probably hampering its 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. You can see the 2 risks we have identified for Tianjin Tianyao Pharmaceuticals by visiting our risks dashboard for free on our platform here.

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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.