Tonghua Dongbao Pharmaceutical Co., Ltd.'s (SHSE:600867) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

With its stock down 24% over the past three months, it is easy to disregard Tonghua Dongbao Pharmaceutical (SHSE:600867). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Tonghua Dongbao Pharmaceutical's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Tonghua Dongbao Pharmaceutical

How Do You 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 Tonghua Dongbao Pharmaceutical is:

15% = CN¥1.1b ÷ CN¥7.4b (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.15.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Tonghua Dongbao Pharmaceutical's Earnings Growth And 15% ROE

To start with, Tonghua Dongbao Pharmaceutical's ROE looks acceptable. Especially when compared to the industry average of 7.6% the company's ROE looks pretty impressive. This probably laid the ground for Tonghua Dongbao Pharmaceutical's moderate 9.2% net income growth seen over the past five years.

We then performed a comparison between Tonghua Dongbao Pharmaceutical's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 9.2% 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. Doing so will help them establish if the stock's future looks promising or ominous. Is Tonghua Dongbao Pharmaceutical fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Tonghua Dongbao Pharmaceutical Using Its Retained Earnings Effectively?

With a three-year median payout ratio of 47% (implying that the company retains 53% of its profits), it seems that Tonghua Dongbao Pharmaceutical is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Additionally, Tonghua Dongbao Pharmaceutical has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 35% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.

Summary

Overall, we are quite pleased with Tonghua Dongbao Pharmaceutical's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. 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 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.

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