Boasting A 67% Return On Equity, Is Sinco Pharmaceuticals Holdings Limited (HKG:6833) A Top Quality Stock?

By
Simply Wall St
Published
March 18, 2022
SEHK:6833
Source: Shutterstock

Many investors are still learning about the various metrics that can be useful when analysing a stock. This article is for those who would like to learn about Return On Equity (ROE). We'll use ROE to examine Sinco Pharmaceuticals Holdings Limited (HKG:6833), by way of a worked example.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Sinco Pharmaceuticals Holdings

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 Sinco Pharmaceuticals Holdings is:

67% = CN¥161m ÷ CN¥240m (Based on the trailing twelve months to June 2021).

The 'return' is the yearly profit. One way to conceptualize this is that for each HK$1 of shareholders' capital it has, the company made HK$0.67 in profit.

Does Sinco Pharmaceuticals Holdings Have A Good Return On Equity?

By comparing a company's ROE with its industry average, we can get a quick measure of how good it is. However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification. As you can see in the graphic below, Sinco Pharmaceuticals Holdings has a higher ROE than the average (8.5%) in the Healthcare industry.

roe
SEHK:6833 Return on Equity March 18th 2022

That's clearly a positive. However, bear in mind that a high ROE doesn’t necessarily indicate efficient profit generation. Especially when a firm uses high levels of debt to finance its debt which may boost its ROE but the high leverage puts the company at risk.

The Importance Of Debt To Return On Equity

Most companies need money -- from somewhere -- to grow their profits. That cash can come from issuing shares, retained earnings, or debt. In the first and second cases, the ROE will reflect this use of cash for investment in the business. In the latter case, the debt required for growth will boost returns, but will not impact the shareholders' equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.

Sinco Pharmaceuticals Holdings' Debt And Its 67% ROE

It's worth noting the high use of debt by Sinco Pharmaceuticals Holdings, leading to its debt to equity ratio of 1.38. Its ROE is pretty impressive but, it would have probably been lower without the use of debt. Investors should think carefully about how a company might perform if it was unable to borrow so easily, because credit markets do change over time.

Conclusion

Return on equity is one way we can compare its business quality of different companies. A company that can achieve a high return on equity without debt could be considered a high quality business. If two companies have around the same level of debt to equity, and one has a higher ROE, I'd generally prefer the one with higher ROE.

But ROE is just one piece of a bigger puzzle, since high quality businesses often trade on high multiples of earnings. It is important to consider other factors, such as future profit growth -- and how much investment is required going forward. Check the past profit growth by Sinco Pharmaceuticals Holdings by looking at this visualization of past earnings, revenue and cash flow.

Of course Sinco Pharmaceuticals Holdings may not be the best stock to buy. So you may wish to see this free collection of other companies that have high ROE and low debt.

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