Is Weakness In Hunan Jiudian Pharmaceutical Co., Ltd. (SZSE:300705) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

With its stock down 36% over the past three months, it is easy to disregard Hunan Jiudian Pharmaceutical (SZSE:300705). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Hunan Jiudian Pharmaceutical's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Hunan Jiudian Pharmaceutical

How Is ROE Calculated?

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 Hunan Jiudian Pharmaceutical is:

21% = CN¥508m ÷ CN¥2.4b (Based on the trailing twelve months to September 2024).

The 'return' is the profit over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.21 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Hunan Jiudian Pharmaceutical's Earnings Growth And 21% ROE

To begin with, Hunan Jiudian Pharmaceutical seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 7.7%. This certainly adds some context to Hunan Jiudian Pharmaceutical's exceptional 40% net income growth seen over the past five years. However, there could also be other causes behind this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Hunan Jiudian Pharmaceutical's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 9.1%.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Hunan Jiudian Pharmaceutical is trading on a high P/E or a low P/E, relative to its industry.

Is Hunan Jiudian Pharmaceutical Making Efficient Use Of Its Profits?

Hunan Jiudian Pharmaceutical's three-year median payout ratio is a pretty moderate 26%, meaning the company retains 74% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Hunan Jiudian Pharmaceutical is reinvesting its earnings efficiently.

Besides, Hunan Jiudian Pharmaceutical has been paying dividends over a period of seven years. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 25%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 25%.

Conclusion

In total, we are pretty happy with Hunan Jiudian Pharmaceutical's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.