Declining Stock and Decent Financials: Is The Market Wrong About Nang Kuang Pharmaceutical Co., Ltd. (GTSM:1752)?

It is hard to get excited after looking at Nang Kuang Pharmaceutical's (GTSM:1752) recent performance, when its stock has declined 4.4% over the past three months. 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 Nang Kuang Pharmaceutical's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Nang Kuang 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 Nang Kuang Pharmaceutical is:

10% = NT$216m ÷ NT$2.2b (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. Another way to think of that is that for every NT$1 worth of equity, the company was able to earn NT$0.10 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. 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.

A Side By Side comparison of Nang Kuang Pharmaceutical's Earnings Growth And 10% ROE

At first glance, Nang Kuang Pharmaceutical seems to have a decent ROE. Especially when compared to the industry average of 8.1% the company's ROE looks pretty impressive. As you might expect, the 3.2% net income decline reported by Nang Kuang Pharmaceutical is a bit of a surprise. Therefore, there might be some other aspects that could explain this. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

That being said, we compared Nang Kuang Pharmaceutical's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 5.9% in the same period.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Nang Kuang Pharmaceutical fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Nang Kuang Pharmaceutical Efficiently Re-investing Its Profits?

Nang Kuang 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 87% (or a retention ratio of 13%). With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. You can see the 2 risks we have identified for Nang Kuang Pharmaceutical by visiting our risks dashboard for free on our platform here.

Moreover, Nang Kuang Pharmaceutical has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

On the whole, we do feel that Nang Kuang Pharmaceutical has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. So it may be worth checking this free detailed graph of Nang Kuang Pharmaceutical's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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