Tonghua Dongbao Pharmaceutical Co., Ltd.'s (SHSE:600867) Stock's Been Going Strong: Could Weak Financials Mean The Market Will Correct Its Share Price?

Tonghua Dongbao Pharmaceutical's (SHSE:600867) stock is up by a considerable 8.0% over the past month. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Particularly, we will be paying attention to Tonghua Dongbao Pharmaceutical's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Tonghua Dongbao Pharmaceutical

How Do You 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 Tonghua Dongbao Pharmaceutical is:

5.3% = CN¥341m ÷ CN¥6.4b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.05 in profit.

What Has ROE Got To Do With 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.

Tonghua Dongbao Pharmaceutical's Earnings Growth And 5.3% ROE

When you first look at it, Tonghua Dongbao Pharmaceutical's ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 7.7% either. Therefore, Tonghua Dongbao Pharmaceutical's flat earnings over the past five years can possibly be explained by the low ROE amongst other factors.

We then compared Tonghua Dongbao Pharmaceutical's net income growth with the industry and found that the average industry growth rate was 9.1% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. 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. 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 high three-year median payout ratio of 57% (implying that the company keeps only 43% of its income) of its business to reinvest into its business), most of Tonghua Dongbao Pharmaceutical's profits are being paid to shareholders, which explains the absence of growth in earnings.

Additionally, Tonghua Dongbao Pharmaceutical has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Conclusion

Overall, we would be extremely cautious before making any decision on Tonghua Dongbao Pharmaceutical. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.