Zhejiang Cheng Yi Pharmaceutical Co., Ltd.'s (SHSE:603811) Stock Is Going Strong: Have Financials A Role To Play?

Simply Wall St · 09/29 01:57

Zhejiang Cheng Yi Pharmaceutical (SHSE:603811) has had a great run on the share market with its stock up by a significant 12% over the last three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study Zhejiang Cheng Yi Pharmaceutical's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Zhejiang Cheng Yi Pharmaceutical

How To Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Zhejiang Cheng Yi Pharmaceutical is:

12% = CN¥148m ÷ CN¥1.2b (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.12 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of Zhejiang Cheng Yi Pharmaceutical's Earnings Growth And 12% ROE

At first glance, Zhejiang Cheng Yi Pharmaceutical seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 7.6%. Yet, Zhejiang Cheng Yi Pharmaceutical has posted measly growth of 4.9% over the past five years. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or poor allocation of capital.

As a next step, we compared Zhejiang Cheng Yi Pharmaceutical'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 9.0% in the same period.

past-earnings-growth
SHSE:603811 Past Earnings Growth September 29th 2024

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

Is Zhejiang Cheng Yi Pharmaceutical Using Its Retained Earnings Effectively?

Despite having a moderate three-year median payout ratio of 36% (implying that the company retains the remaining 64% of its income), Zhejiang Cheng Yi Pharmaceutical's earnings growth was quite low. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, Zhejiang Cheng Yi Pharmaceutical has paid dividends over a period of seven years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Conclusion

On the whole, we do feel that Zhejiang Cheng Yi Pharmaceutical has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 1 risk we have identified for Zhejiang Cheng Yi Pharmaceutical by visiting our risks dashboard for free on our platform here.