Most readers would already be aware that Beijing Tong Ren Tang Chinese Medicine's (HKG:3613) stock increased significantly by 9.9% over the past month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on Beijing Tong Ren Tang Chinese Medicine's ROE.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Beijing Tong Ren Tang Chinese Medicine is:
16% = HK$442m ÷ HK$2.8b (Based on the trailing twelve months to June 2020).
The 'return' is the yearly profit. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.16 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
A Side By Side comparison of Beijing Tong Ren Tang Chinese Medicine's Earnings Growth And 16% ROE
To start with, Beijing Tong Ren Tang Chinese Medicine's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 10%. Probably as a result of this, Beijing Tong Ren Tang Chinese Medicine was able to see a decent growth of 9.7% over the last five years.
As a next step, we compared Beijing Tong Ren Tang Chinese Medicine's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 16% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Beijing Tong Ren Tang Chinese Medicine is trading on a high P/E or a low P/E, relative to its industry.
Is Beijing Tong Ren Tang Chinese Medicine Making Efficient Use Of Its Profits?
Beijing Tong Ren Tang Chinese Medicine has a healthy combination of a moderate three-year median payout ratio of 32% (or a retention ratio of 68%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.
Additionally, Beijing Tong Ren Tang Chinese Medicine has paid dividends over a period of seven years which means that the company is pretty serious about sharing its profits with shareholders. 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 36%. As a result, Beijing Tong Ren Tang Chinese Medicine's ROE is not expected to change by much either, which we inferred from the analyst estimate of 18% for future ROE.
In total, we are pretty happy with Beijing Tong Ren Tang Chinese Medicine's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a respectable growth in its earnings. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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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