Guiyang Xintian Pharmaceutical Co.,Ltd. (SZSE:002873) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?

Guiyang Xintian PharmaceuticalLtd (SZSE:002873) has had a great run on the share market with its stock up by a significant 21% over the last three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. Particularly, we will be paying attention to Guiyang Xintian PharmaceuticalLtd's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Guiyang Xintian PharmaceuticalLtd

How To 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 Guiyang Xintian PharmaceuticalLtd is:

5.2% = CN¥54m ÷ CN¥1.0b (Based on the trailing twelve months to September 2024).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.05 in profit.

Why Is ROE Important For 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. 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.

Guiyang Xintian PharmaceuticalLtd's Earnings Growth And 5.2% ROE

When you first look at it, Guiyang Xintian PharmaceuticalLtd's ROE doesn't look that attractive. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 7.7%. Thus, the low net income growth of 2.5% seen by Guiyang Xintian PharmaceuticalLtd over the past five years could probably be the result of the low ROE.

Next, on comparing with the industry net income growth, we found that Guiyang Xintian PharmaceuticalLtd's reported growth was lower than the industry growth of 9.1% over the last few years, which is not something we like to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 Guiyang Xintian PharmaceuticalLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Guiyang Xintian PharmaceuticalLtd Using Its Retained Earnings Effectively?

Guiyang Xintian PharmaceuticalLtd's low three-year median payout ratio of 21% (or a retention ratio of 79%) should mean that the company is retaining most of its earnings to fuel its growth. This should be reflected in its earnings growth number, but that's not the case. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, Guiyang Xintian PharmaceuticalLtd has paid dividends over a period of seven years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Summary

In total, we're a bit ambivalent about Guiyang Xintian PharmaceuticalLtd'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. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. To know the 4 risks we have identified for Guiyang Xintian PharmaceuticalLtd visit our risks dashboard for free.

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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.