Declining Stock and Decent Financials: Is The Market Wrong About YiChang HEC ChangJiang Pharmaceutical Co., Ltd. (HKG:1558)?

It is hard to get excited after looking at YiChang HEC ChangJiang Pharmaceutical's (HKG:1558) recent performance, when its stock has declined 20% over the past month. 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 YiChang HEC ChangJiang Pharmaceutical's ROE.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for YiChang HEC ChangJiang Pharmaceutical

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for YiChang HEC ChangJiang Pharmaceutical is:

23% = CN¥1.9b ÷ CN¥7.9b (Based on the trailing twelve months to December 2023).

The 'return' refers to a company's earnings over the last year. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.23.

What Has ROE Got To Do With 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. 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.

YiChang HEC ChangJiang Pharmaceutical's Earnings Growth And 23% ROE

To begin with, YiChang HEC ChangJiang Pharmaceutical has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 12% the company's ROE is quite impressive. For this reason, YiChang HEC ChangJiang Pharmaceutical's five year net income decline of 16% raises the question as to why the high ROE didn't translate into earnings growth. So, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.

However, when we compared YiChang HEC ChangJiang Pharmaceutical's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 5.9% 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 YiChang HEC ChangJiang Pharmaceutical is trading on a high P/E or a low P/E, relative to its industry.

Is YiChang HEC ChangJiang Pharmaceutical Efficiently Re-investing Its Profits?

While the company did payout a portion of its dividend in the past, it currently doesn't pay a regular dividend. This implies that potentially all of its profits are being reinvested in the business.

Summary

Overall, we feel that YiChang HEC ChangJiang Pharmaceutical certainly does have some positive factors to consider. 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. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard will have the 1 risk we have identified for YiChang HEC ChangJiang Pharmaceutical.

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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.