Is Shandong Wohua Pharmaceutical Co., Ltd.'s (SZSE:002107) Stock On A Downtrend As A Result Of Its Poor Financials?

Shandong Wohua Pharmaceutical (SZSE:002107) has had a rough month with its share price down 21%. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. Particularly, we will be paying attention to Shandong Wohua Pharmaceutical's ROE today.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Shandong Wohua Pharmaceutical

How Do You 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 Shandong Wohua Pharmaceutical is:

3.9% = CN¥33m ÷ CN¥842m (Based on the trailing twelve months to March 2024).

The 'return' is the profit 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¥0.04.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Shandong Wohua Pharmaceutical's Earnings Growth And 3.9% ROE

As you can see, Shandong Wohua Pharmaceutical's ROE looks pretty weak. Not just that, even compared to the industry average of 7.7%, the company's ROE is entirely unremarkable. For this reason, Shandong Wohua Pharmaceutical's five year net income decline of 2.5% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.

However, when we compared Shandong Wohua Pharmaceutical'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.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Shandong Wohua Pharmaceutical's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shandong Wohua Pharmaceutical Using Its Retained Earnings Effectively?

Shandong Wohua Pharmaceutical's very high three-year median payout ratio of 108% over the last three years suggests that the company is paying its shareholders more than what it is earning and this explains the company's shrinking earnings. Paying a dividend beyond their means is usually not viable over the long term. Our risks dashboard should have the 3 risks we have identified for Shandong Wohua Pharmaceutical.

Additionally, Shandong Wohua 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

On the whole, Shandong Wohua Pharmaceutical's performance is quite a big let-down. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. So it may be worth checking this free detailed graph of Shandong Wohua Pharmaceutical's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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.