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

Hualan Biological Engineering (SZSE:002007) has had a rough three months with its share price down 6.9%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Hualan Biological Engineering's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Hualan Biological Engineering

How To Calculate Return On Equity?

ROE 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 Hualan Biological Engineering is:

11% = CN¥1.5b ÷ CN¥14b (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¥0.11 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Hualan Biological Engineering's Earnings Growth And 11% ROE

To begin with, Hualan Biological Engineering seems to have a respectable ROE. Especially when compared to the industry average of 5.9% the company's ROE looks pretty impressive. Given the circumstances, we can't help but wonder why Hualan Biological Engineering saw little to no growth 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.

As a next step, we compared Hualan Biological Engineering's net income growth with the industry and discovered that the industry saw an average growth of 7.6% in the same period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is Hualan Biological Engineering fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Hualan Biological Engineering Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 39% (implying that the company keeps 61% of its income) over the last three years, Hualan Biological Engineering has seen a negligible amount of growth in earnings as we saw above. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, Hualan Biological Engineering has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 34%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 13%.

Summary

Overall, we feel that Hualan Biological Engineering certainly does have some positive factors to consider. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.