Should Weakness in Guangzhou Baiyunshan Pharmaceutical Holdings Company Limited's (HKG:874) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

Guangzhou Baiyunshan Pharmaceutical Holdings (HKG:874) has had a rough three months with its share price down 7.1%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Guangzhou Baiyunshan Pharmaceutical Holdings' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Guangzhou Baiyunshan Pharmaceutical 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 Guangzhou Baiyunshan Pharmaceutical Holdings is:

12% = CN¥4.5b ÷ CN¥36b (Based on the trailing twelve months to September 2023).

The 'return' is the profit over the last twelve months. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.12.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Guangzhou Baiyunshan Pharmaceutical Holdings' Earnings Growth And 12% ROE

To start with, Guangzhou Baiyunshan Pharmaceutical Holdings' ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 9.6%. However, for some reason, the higher returns aren't reflected in Guangzhou Baiyunshan Pharmaceutical Holdings' meagre five year net income growth average of 4.7%. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn't been able to do so. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or poor allocation of capital.

We then compared Guangzhou Baiyunshan Pharmaceutical Holdings' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 11% in the same 5-year period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is 874 worth today? The intrinsic value infographic in our free research report helps visualize whether 874 is currently mispriced by the market.

Is Guangzhou Baiyunshan Pharmaceutical Holdings Making Efficient Use Of Its Profits?

While Guangzhou Baiyunshan Pharmaceutical Holdings has a decent three-year median payout ratio of 29% (or a retention ratio of 71%), it has seen very little growth in earnings. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, Guangzhou Baiyunshan Pharmaceutical Holdings has paid dividends over a period of nine years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 27%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 11%.

Conclusion

Overall, we feel that Guangzhou Baiyunshan Pharmaceutical Holdings certainly does have some positive factors to consider. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.