Declining Stock and Solid Fundamentals: Is The Market Wrong About CSPC Innovation Pharmaceutical Co., Ltd. (SZSE:300765)?

CSPC Innovation Pharmaceutical (SZSE:300765) has had a rough three months with its share price down 15%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to CSPC Innovation Pharmaceutical's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for CSPC Innovation Pharmaceutical

How To Calculate Return On Equity?

ROE 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 CSPC Innovation Pharmaceutical is:

13% = CN¥707m ÷ CN¥5.5b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax 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¥0.13 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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

CSPC Innovation Pharmaceutical's Earnings Growth And 13% ROE

At first glance, CSPC Innovation Pharmaceutical seems to have a decent ROE. Especially when compared to the industry average of 7.7% the company's ROE looks pretty impressive. This certainly adds some context to CSPC Innovation Pharmaceutical's exceptional 27% 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 CSPC Innovation 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 9.2%.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 CSPC Innovation Pharmaceutical is trading on a high P/E or a low P/E, relative to its industry.

Is CSPC Innovation Pharmaceutical Using Its Retained Earnings Effectively?

CSPC Innovation Pharmaceutical has a really low three-year median payout ratio of 15%, meaning that it has the remaining 85% left over to reinvest into its business. So it looks like CSPC Innovation Pharmaceutical is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Additionally, CSPC Innovation Pharmaceutical has paid dividends over a period of four years which means that the company is pretty serious about sharing its profits with shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 36% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.

Summary

Overall, we are quite pleased with CSPC Innovation Pharmaceutical's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com