Has YiChang HEC ChangJiang Pharmaceutical Co., Ltd.'s (HKG:1558) Impressive Stock Performance Got Anything to Do With Its Fundamentals?

YiChang HEC ChangJiang Pharmaceutical (HKG:1558) has had a great run on the share market with its stock up by a significant 22% over the last three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. 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.

View our latest analysis for YiChang HEC ChangJiang Pharmaceutical

How Do You 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 YiChang HEC ChangJiang Pharmaceutical is:

18% = CN¥1.5b ÷ CN¥8.7b (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.18 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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 18% ROE

To begin with, YiChang HEC ChangJiang Pharmaceutical seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 11%. As you might expect, the 2.1% net income decline reported by YiChang HEC ChangJiang Pharmaceutical is a bit of a surprise. We reckon that there could be some other factors at play here that are preventing the company's growth. These include low earnings retention or poor allocation of capital.

So, as a next step, we compared YiChang HEC ChangJiang Pharmaceutical's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 4.3% over the last few years.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is YiChang HEC ChangJiang Pharmaceutical fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is YiChang HEC ChangJiang Pharmaceutical Making Efficient Use Of Its Profits?

Because YiChang HEC ChangJiang Pharmaceutical doesn't pay any regular dividends, we infer that it is retaining all of its profits, which is rather perplexing when you consider the fact that there is no earnings growth to show for it. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Summary

In total, it does look like YiChang HEC ChangJiang Pharmaceutical 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. 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 would have the 2 risks 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.