Does Hisamitsu Pharmaceutical Co., Inc.'s (TSE:4530) Weak Fundamentals Mean A Downturn In Its Stock Should Be Expected?

Most readers would already know that Hisamitsu Pharmaceutical's (TSE:4530) stock increased by 4.1% over the past three months. Given that the markets usually pay for the long-term financial health of a company, we wonder if the current momentum in the share price will keep up, given that the company's financials don't look very promising. Particularly, we will be paying attention to Hisamitsu Pharmaceutical'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Hisamitsu Pharmaceutical

How To 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 Hisamitsu Pharmaceutical is:

5.5% = JP¥15b ÷ JP¥276b (Based on the trailing twelve months to August 2024).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every ¥1 worth of equity, the company was able to earn ¥0.05 in profit.

What Is The Relationship Between ROE And 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 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.

Hisamitsu Pharmaceutical's Earnings Growth And 5.5% ROE

At first glance, Hisamitsu Pharmaceutical's ROE doesn't look very promising. Next, when compared to the average industry ROE of 7.8%, the company's ROE leaves us feeling even less enthusiastic. For this reason, Hisamitsu Pharmaceutical's five year net income decline of 4.3% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared Hisamitsu 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 4.3% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. 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 Hisamitsu Pharmaceutical is trading on a high P/E or a low P/E, relative to its industry.

Is Hisamitsu Pharmaceutical Efficiently Re-investing Its Profits?

Hisamitsu Pharmaceutical's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 57% (or a retention ratio of 43%). With only very little left to reinvest into the business, growth in earnings is far from likely.

In addition, Hisamitsu Pharmaceutical 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.

Summary

In total, we would have a hard think before deciding on any investment action concerning Hisamitsu Pharmaceutical. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.