Chengdu Kanghong Pharmaceutical Group Co., Ltd (SZSE:002773) On An Uptrend: Could Fundamentals Be Driving The Stock?

Chengdu Kanghong Pharmaceutical Group's (SZSE:002773) stock is up by 8.7% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Chengdu Kanghong Pharmaceutical Group's ROE.

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.

See our latest analysis for Chengdu Kanghong Pharmaceutical Group

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 Chengdu Kanghong Pharmaceutical Group is:

12% = CN¥932m ÷ CN¥7.6b (Based on the trailing twelve months to September 2023).

The 'return' is the amount earned after tax over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.12 in profit.

What Has ROE Got To Do With 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. 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.

A Side By Side comparison of Chengdu Kanghong Pharmaceutical Group's Earnings Growth And 12% ROE

At first glance, Chengdu Kanghong Pharmaceutical Group seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 8.1%. Given the circumstances, we can't help but wonder why Chengdu Kanghong Pharmaceutical Group 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. These include low earnings retention or poor allocation of capital.

As a next step, we compared Chengdu Kanghong Pharmaceutical Group's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 10% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Chengdu Kanghong Pharmaceutical Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Chengdu Kanghong Pharmaceutical Group Using Its Retained Earnings Effectively?

Chengdu Kanghong Pharmaceutical Group's low three-year median payout ratio of 15% (implying that the company keeps85% of its income) should mean that the company is retaining most of its earnings to fuel its growth and this should be reflected in its growth number, but that's not the case.

In addition, Chengdu Kanghong Pharmaceutical Group has been paying dividends over a period of eight 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

Overall, we feel that Chengdu Kanghong Pharmaceutical Group 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. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.