Hubei Hongyuan Pharmaceutical Technology Co., Ltd.'s (SZSE:301246) Stock is Soaring But Financials Seem Inconsistent: Will The Uptrend Continue?

Hubei Hongyuan Pharmaceutical Technology (SZSE:301246) has had a great run on the share market with its stock up by a significant 18% over the last week. 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 Hubei Hongyuan Pharmaceutical Technology'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Hubei Hongyuan Pharmaceutical Technology

How Do You 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 Hubei Hongyuan Pharmaceutical Technology is:

1.3% = CN¥58m ÷ CN¥4.3b (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¥0.01 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 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.

Hubei Hongyuan Pharmaceutical Technology's Earnings Growth And 1.3% ROE

It is quite clear that Hubei Hongyuan Pharmaceutical Technology's ROE is rather low. Not just that, even compared to the industry average of 7.6%, the company's ROE is entirely unremarkable. Given the circumstances, the significant decline in net income by 6.2% seen by Hubei Hongyuan Pharmaceutical Technology over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

However, when we compared Hubei Hongyuan Pharmaceutical Technology'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. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Hubei Hongyuan Pharmaceutical Technology is trading on a high P/E or a low P/E, relative to its industry.

Is Hubei Hongyuan Pharmaceutical Technology Using Its Retained Earnings Effectively?

When we piece together Hubei Hongyuan Pharmaceutical Technology's low three-year median payout ratio of 22% (where it is retaining 78% of its profits), calculated for the last three-year period, we are puzzled by the lack of growth. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Only recently, Hubei Hongyuan Pharmaceutical Technology stated paying a dividend. This likely means that the management might have concluded that its shareholders have a strong preference for dividends.

Summary

Overall, we have mixed feelings about Hubei Hongyuan Pharmaceutical Technology. 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 3 risks we have identified for Hubei Hongyuan Pharmaceutical Technology 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.