Can Mixed Financials Have A Negative Impact on China Pioneer Pharma Holdings Limited's 's (HKG:1345) Current Price Momentum?

Most readers would already know that China Pioneer Pharma Holdings' (HKG:1345) stock increased by 4.3% over the past three months. However, the company's financials look a bit inconsistent and market outcomes are ultimately driven by long-term fundamentals, meaning that the stock could head in either direction. Specifically, we decided to study China Pioneer Pharma Holdings' 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.

Check out our latest analysis for China Pioneer Pharma Holdings

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 China Pioneer Pharma Holdings is:

3.8% = CN¥36m ÷ CN¥955m (Based on the trailing twelve months to June 2020).

The 'return' is the income the business earned over the last year. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.04 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. 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.

China Pioneer Pharma Holdings' Earnings Growth And 3.8% ROE

At first glance, China Pioneer Pharma Holdings' ROE doesn't look very promising. Next, when compared to the average industry ROE of 6.4%, the company's ROE leaves us feeling even less enthusiastic. Therefore, it might not be wrong to say that the five year net income decline of 20% seen by China Pioneer Pharma Holdings was probably the result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

So, as a next step, we compared China Pioneer Pharma Holdings' performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 2.7% in the same period.

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. If you're wondering about China Pioneer Pharma Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is China Pioneer Pharma Holdings Using Its Retained Earnings Effectively?

Looking at its three-year median payout ratio of 37% (or a retention ratio of 63%) which is pretty normal, China Pioneer Pharma Holdings' declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, China Pioneer Pharma Holdings has been paying dividends for seven years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking.

Conclusion

On the whole, we feel that the performance shown by China Pioneer Pharma Holdings can be open to many interpretations. 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. You can see the 4 risks we have identified for China Pioneer Pharma Holdings by visiting our risks dashboard for free on our platform here.

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This article by Simply Wall St is general in nature. 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.
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