Declining Stock and Decent Financials: Is The Market Wrong About Hualan Biological Engineering Inc. (SZSE:002007)?

It is hard to get excited after looking at Hualan Biological Engineering's (SZSE:002007) recent performance, when its stock has declined 14% over the past three months. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Hualan Biological Engineering's ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Hualan Biological Engineering

How To 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 Hualan Biological Engineering is:

12% = CN¥1.7b ÷ CN¥14b (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¥0.12.

What Is The Relationship Between ROE And 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. 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 Hualan Biological Engineering's Earnings Growth And 12% ROE

At first glance, Hualan Biological Engineering seems to have a decent ROE. Especially when compared to the industry average of 5.8% the company's ROE looks pretty impressive. However, we are curious as to how the high returns still resulted in flat growth for Hualan Biological Engineering in the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

Next, on comparing with the industry net income growth, we found that the industry grew its earnings by 5.4% over the last few years.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is 002007 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Hualan Biological Engineering Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 35% (or a retention ratio of 65%), Hualan Biological Engineering hasn't seen much growth in its earnings. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, Hualan Biological Engineering has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 35% of its profits over the next three years. As a result, Hualan Biological Engineering's ROE is not expected to change by much either, which we inferred from the analyst estimate of 14% for future ROE.

Summary

On the whole, we do feel that Hualan Biological Engineering has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.

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