Shandong Wohua Pharmaceutical Co., Ltd.'s (SZSE:002107) On An Uptrend But Financial Prospects Look Pretty Weak: Is The Stock Overpriced?

Shandong Wohua Pharmaceutical (SZSE:002107) has had a great run on the share market with its stock up by a significant 13% over the last week. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. Specifically, we decided to study Shandong Wohua Pharmaceutical's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Shandong Wohua Pharmaceutical

How Do You 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 Shandong Wohua Pharmaceutical is:

3.8% = CN¥27m ÷ CN¥699m (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.04 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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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 3.8% ROE

It is hard to argue that Shandong Wohua Pharmaceutical's ROE is much good in and of itself. Even when compared to the industry average of 7.6%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 10.0% seen by Shandong Wohua Pharmaceutical over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.

That being said, we compared Shandong Wohua Pharmaceutical's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 9.0% in the same 5-year 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. Has the market priced in the future outlook for 002107? You can find out in our latest intrinsic value infographic research report

Is Shandong Wohua Pharmaceutical Making Efficient Use Of Its Profits?

Shandong Wohua Pharmaceutical's very high three-year median payout ratio of 128% 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 higher than reported profits is not a sustainable move. You can see the 3 risks we have identified for Shandong Wohua Pharmaceutical by visiting our risks dashboard for free on our platform here.

In addition, Shandong Wohua Pharmaceutical 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.

Summary

In total, we would have a hard think before deciding on any investment action concerning Shandong Wohua Pharmaceutical. 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. So far, we've only made a quick discussion around the company's earnings growth. 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.