Is GuangYuYuan Chinese Herbal Medicine Co., Ltd.'s (SHSE:600771) Recent Price Movement Underpinned By Its Weak Fundamentals?

With its stock down 22% over the past three months, it is easy to disregard GuangYuYuan Chinese Herbal Medicine (SHSE:600771). It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on GuangYuYuan Chinese Herbal Medicine's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for GuangYuYuan Chinese Herbal Medicine

How Is ROE Calculated?

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 GuangYuYuan Chinese Herbal Medicine is:

7.3% = CN¥114m ÷ CN¥1.6b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.07.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

A Side By Side comparison of GuangYuYuan Chinese Herbal Medicine's Earnings Growth And 7.3% ROE

On the face of it, GuangYuYuan Chinese Herbal Medicine's ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.6%. Having said that, GuangYuYuan Chinese Herbal Medicine's five year net income decline rate was 51%. Bear in mind, the company does have a slightly low ROE. Hence, this goes some way in explaining the shrinking earnings.

However, when we compared GuangYuYuan Chinese Herbal Medicine's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 9.2% in the same period. This is quite worrisome.

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. If you're wondering about GuangYuYuan Chinese Herbal Medicine's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is GuangYuYuan Chinese Herbal Medicine Making Efficient Use Of Its Profits?

GuangYuYuan Chinese Herbal Medicine doesn't pay any regular dividends, meaning that the company is keeping all of its profits, which makes us wonder why it is retaining its earnings if it can't use them to grow its business. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Summary

Overall, we have mixed feelings about GuangYuYuan Chinese Herbal 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. 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 1 risk we have identified for GuangYuYuan Chinese Herbal Medicine 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com