Weak Financial Prospects Seem To Be Dragging Down Shanghai Shen Lian Biomedical Corporation (SHSE:688098) Stock

With its stock down 15% over the past month, it is easy to disregard Shanghai Shen Lian Biomedical (SHSE:688098). Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. Specifically, we decided to study Shanghai Shen Lian Biomedical's ROE in this article.

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.

View our latest analysis for Shanghai Shen Lian Biomedical

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 Shanghai Shen Lian Biomedical is:

0.7% = CN¥11m ÷ CN¥1.5b (Based on the trailing twelve months to March 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¥0.01 in profit.

What Has ROE Got To Do With Earnings Growth?

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

Shanghai Shen Lian Biomedical's Earnings Growth And 0.7% ROE

As you can see, Shanghai Shen Lian Biomedical's ROE looks pretty weak. Not just that, even compared to the industry average of 7.7%, the company's ROE is entirely unremarkable. Therefore, it might not be wrong to say that the five year net income decline of 26% seen by Shanghai Shen Lian Biomedical was possibly a result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

However, when we compared Shanghai Shen Lian Biomedical'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.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Shanghai Shen Lian Biomedical fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Shanghai Shen Lian Biomedical Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 53% (implying that 47% of the profits are retained), most of Shanghai Shen Lian Biomedical's profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 4 risks we have identified for Shanghai Shen Lian Biomedical by visiting our risks dashboard for free on our platform here.

In addition, Shanghai Shen Lian Biomedical has been paying dividends over a period of four years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.

Summary

In total, we would have a hard think before deciding on any investment action concerning Shanghai Shen Lian Biomedical. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. So far, we've only made a quick discussion around the company's earnings growth. To gain further insights into Shanghai Shen Lian Biomedical's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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.