Is The Market Rewarding Yantai Dongcheng Pharmaceutical Group Co.,Ltd. (SZSE:002675) With A Negative Sentiment As A Result Of Its Mixed Fundamentals?

It is hard to get excited after looking at Yantai Dongcheng Pharmaceutical GroupLtd's (SZSE:002675) recent performance, when its stock has declined 15% over the past three months. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. In this article, we decided to focus on Yantai Dongcheng Pharmaceutical GroupLtd's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. 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 Yantai Dongcheng Pharmaceutical GroupLtd

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 Yantai Dongcheng Pharmaceutical GroupLtd is:

4.4% = CN¥257m ÷ CN¥5.9b (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.04 in profit.

What Is The Relationship Between ROE And 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.

Yantai Dongcheng Pharmaceutical GroupLtd's Earnings Growth And 4.4% ROE

As you can see, Yantai Dongcheng Pharmaceutical GroupLtd's ROE looks pretty weak. Even when compared to the industry average of 5.8%, the ROE figure is pretty disappointing. Therefore, it might not be wrong to say that the five year net income decline of 3.4% seen by Yantai Dongcheng Pharmaceutical GroupLtd was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.

So, as a next step, we compared Yantai Dongcheng Pharmaceutical GroupLtd's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 5.4% over the last few years.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Yantai Dongcheng Pharmaceutical GroupLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Yantai Dongcheng Pharmaceutical GroupLtd Making Efficient Use Of Its Profits?

Looking at its three-year median payout ratio of 49% (or a retention ratio of 51%) which is pretty normal, Yantai Dongcheng Pharmaceutical GroupLtd's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Additionally, Yantai Dongcheng Pharmaceutical GroupLtd 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 26% over the next three years. As a result, the expected drop in Yantai Dongcheng Pharmaceutical GroupLtd's payout ratio explains the anticipated rise in the company's future ROE to 7.7%, over the same period.

Conclusion

In total, we're a bit ambivalent about Yantai Dongcheng Pharmaceutical GroupLtd's performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. 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 latest analysts predictions for the company, check out this visualization of analyst forecasts 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.

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