Sino Biopharmaceutical Limited's (HKG:1177) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

With its stock down 10% over the past three months, it is easy to disregard Sino Biopharmaceutical (HKG:1177). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on Sino Biopharmaceutical's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Sino Biopharmaceutical

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 Sino Biopharmaceutical is:

12% = CN¥5.1b ÷ CN¥42b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. Another way to think of that is that for every HK$1 worth of equity, the company was able to earn HK$0.12 in profit.

What Is The Relationship Between ROE And 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.

Sino Biopharmaceutical's Earnings Growth And 12% ROE

To begin with, Sino Biopharmaceutical seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 11%. For this reason, Sino Biopharmaceutical's five year net income decline of 14% raises the question as to why the decent ROE didn't translate into growth. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. These include low earnings retention or poor allocation of capital.

However, when we compared Sino Biopharmaceutical's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 4.3% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. 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 Sino Biopharmaceutical is trading on a high P/E or a low P/E, relative to its industry.

Is Sino Biopharmaceutical Making Efficient Use Of Its Profits?

Looking at its three-year median payout ratio of 39% (or a retention ratio of 61%) which is pretty normal, Sino Biopharmaceutical's 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, Sino Biopharmaceutical has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over 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 35%. Regardless, Sino Biopharmaceutical's ROE is speculated to decline to 9.1% despite there being no anticipated change in its payout ratio.

Conclusion

In total, it does look like Sino Biopharmaceutical has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.