China Chemical & Pharmaceutical Co., Ltd. (TPE:1701) Stock's Been Sliding But Fundamentals Look Decent: Will The Market Correct The Share Price In The Future?

With its stock down 3.7% over the past three months, it is easy to disregard China Chemical & Pharmaceutical (TPE:1701). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study China Chemical & Pharmaceutical's ROE in this article.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for China Chemical & Pharmaceutical

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for China Chemical & Pharmaceutical is:

8.1% = NT$535m ÷ NT$6.6b (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. That means that for every NT$1 worth of shareholders' equity, the company generated NT$0.08 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 China Chemical & Pharmaceutical's Earnings Growth And 8.1% ROE

When you first look at it, China Chemical & Pharmaceutical's ROE doesn't look that attractive. However, its ROE is similar to the industry average of 8.3%, so we won't completely dismiss the company. On the other hand, China Chemical & Pharmaceutical reported a moderate 5.9% net income growth over the past five years. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared China Chemical & Pharmaceutical's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 5.7% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 China Chemical & Pharmaceutical is trading on a high P/E or a low P/E, relative to its industry.

Is China Chemical & Pharmaceutical Using Its Retained Earnings Effectively?

While China Chemical & Pharmaceutical has a three-year median payout ratio of 58% (which means it retains 42% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.

Moreover, China Chemical & Pharmaceutical is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Summary

In total, it does look like China Chemical & Pharmaceutical has some positive aspects to its business. Namely, its high earnings growth. We do however feel that the earnings growth number could have been even higher, had the company been reinvesting more of its earnings and paid out less dividends. Up till now, we've only made a short study of the company's growth data. So it may be worth checking this free detailed graph of China Chemical & 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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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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