Can Zhuhai Rundu Pharmaceutical Co., Ltd.'s (SZSE:002923) Weak Financials Pull The Plug On The Stock's Current Momentum On Its Share Price?

Zhuhai Rundu Pharmaceutical (SZSE:002923) has had a great run on the share market with its stock up by a significant 10% 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. Particularly, we will be paying attention to Zhuhai Rundu Pharmaceutical's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Zhuhai Rundu Pharmaceutical

How To Calculate Return On Equity?

Return on equity 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 Zhuhai Rundu Pharmaceutical is:

3.1% = CN¥35m ÷ CN¥1.2b (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¥0.03 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of Zhuhai Rundu Pharmaceutical's Earnings Growth And 3.1% ROE

It is hard to argue that Zhuhai Rundu Pharmaceutical's ROE is much good in and of itself. Even compared to the average industry ROE of 7.6%, the company's ROE is quite dismal. For this reason, Zhuhai Rundu Pharmaceutical's five year net income decline of 6.1% 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. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared Zhuhai Rundu 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 9.0% in the same period. This is quite worrisome.

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. Is Zhuhai Rundu Pharmaceutical fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Zhuhai Rundu Pharmaceutical Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 56% (implying that 44% of the profits are retained), most of Zhuhai Rundu Pharmaceutical's profits are being paid to shareholders, which explains the company's shrinking earnings. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. Our risks dashboard should have the 4 risks we have identified for Zhuhai Rundu Pharmaceutical.

Additionally, Zhuhai Rundu Pharmaceutical has paid dividends over a period of six years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Conclusion

Overall, we would be extremely cautious before making any decision on Zhuhai Rundu Pharmaceutical. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. To gain further insights into Zhuhai Rundu Pharmaceutical's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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.