Is Zhongzhi Pharmaceutical Holdings Limited's(HKG:3737) Recent Stock Performance Tethered To Its Strong Fundamentals?

Zhongzhi Pharmaceutical Holdings' (HKG:3737) stock is up by a considerable 12% over the past week. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Specifically, we decided to study Zhongzhi Pharmaceutical Holdings' ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Zhongzhi Pharmaceutical Holdings

How Do You Calculate Return On Equity?

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 Zhongzhi Pharmaceutical Holdings is:

16% = CN¥128m ÷ CN¥803m (Based on the trailing twelve months to June 2020).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each HK$1 of shareholders' capital it has, the company made HK$0.16 in profit.

Why Is ROE Important For 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.

Zhongzhi Pharmaceutical Holdings' Earnings Growth And 16% ROE

At first glance, Zhongzhi Pharmaceutical Holdings seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 9.4%. Probably as a result of this, Zhongzhi Pharmaceutical Holdings was able to see a decent growth of 11% over the last five years.

Next, on comparing with the industry net income growth, we found that Zhongzhi Pharmaceutical Holdings' growth is quite high when compared to the industry average growth of 7.2% in the same period, which is great to see.

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. Is Zhongzhi Pharmaceutical Holdings fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Zhongzhi Pharmaceutical Holdings Making Efficient Use Of Its Profits?

Zhongzhi Pharmaceutical Holdings has a three-year median payout ratio of 39%, which implies that it retains the remaining 61% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Moreover, Zhongzhi Pharmaceutical Holdings is determined to keep sharing its profits with shareholders which we infer from its long history of five years of paying a dividend.

Summary

Overall, we are quite pleased with Zhongzhi Pharmaceutical Holdings' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. You can see the 1 risk we have identified for Zhongzhi Pharmaceutical 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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