Declining Stock and Decent Financials: Is The Market Wrong About Beijing Tong Ren Tang Chinese Medicine Company Limited (HKG:3613)?

Beijing Tong Ren Tang Chinese Medicine (HKG:3613) has had a rough three months with its share price down 10%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Beijing Tong Ren Tang Chinese Medicine's ROE today.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Beijing Tong Ren Tang Chinese Medicine

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 Beijing Tong Ren Tang Chinese Medicine is:

20% = HK$751m ÷ HK$3.7b (Based on the trailing twelve months to June 2023).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each HK$1 of shareholders' capital it has, the company made HK$0.20 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Beijing Tong Ren Tang Chinese Medicine's Earnings Growth And 20% ROE

To begin with, Beijing Tong Ren Tang Chinese Medicine seems to have a respectable ROE. Especially when compared to the industry average of 13% the company's ROE looks pretty impressive. Despite this, Beijing Tong Ren Tang Chinese Medicine's five year net income growth was quite low averaging at only 3.2%. That's a bit unexpected from a company which has such a high rate of return. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

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 5.6% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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. Has the market priced in the future outlook for 3613? You can find out in our latest intrinsic value infographic research report.

Is Beijing Tong Ren Tang Chinese Medicine Efficiently Re-investing Its Profits?

While Beijing Tong Ren Tang Chinese Medicine has a decent three-year median payout ratio of 40% (or a retention ratio of 60%), it has seen very little growth in earnings. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

In addition, Beijing Tong Ren Tang Chinese Medicine has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 42%. Accordingly, forecasts suggest that Beijing Tong Ren Tang Chinese Medicine's future ROE will be 20% which is again, similar to the current ROE.

Summary

Overall, we feel that Beijing Tong Ren Tang Chinese Medicine 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. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.