Zhejiang Xinguang Pharmaceutical Co., Ltd.'s (SZSE:300519) Stock Going Strong But Fundamentals Look Weak: What Implications Could This Have On The Stock?

Zhejiang Xinguang Pharmaceutical's (SZSE:300519) stock is up by a considerable 26% over the past three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. In this article, we decided to focus on Zhejiang Xinguang Pharmaceutical's ROE.

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.

View our latest analysis for Zhejiang Xinguang Pharmaceutical

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 Zhejiang Xinguang Pharmaceutical is:

5.3% = CN¥43m ÷ CN¥818m (Based on the trailing twelve months to September 2024).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.05.

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. 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 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.

Zhejiang Xinguang Pharmaceutical's Earnings Growth And 5.3% ROE

On the face of it, Zhejiang Xinguang Pharmaceutical's ROE is not much to talk about. Next, when compared to the average industry ROE of 7.7%, the company's ROE leaves us feeling even less enthusiastic. For this reason, Zhejiang Xinguang Pharmaceutical's five year net income decline of 8.8% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.

However, when we compared Zhejiang Xinguang 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 9.1% in the same period. This is quite worrisome.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. 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 Zhejiang Xinguang Pharmaceutical is trading on a high P/E or a low P/E, relative to its industry.

Is Zhejiang Xinguang Pharmaceutical Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 86% (implying that 14% of the profits are retained), most of Zhejiang Xinguang Pharmaceutical's profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 4 risks we have identified for Zhejiang Xinguang Pharmaceutical by visiting our risks dashboard for free on our platform here.

Additionally, Zhejiang Xinguang Pharmaceutical has paid dividends over a period of eight 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 Zhejiang Xinguang Pharmaceutical. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. 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 Zhejiang Xinguang 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.