Tonghua Dongbao Pharmaceutical's (SHSE:600867) stock is up by a considerable 10% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Tonghua Dongbao Pharmaceutical's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
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 Tonghua Dongbao Pharmaceutical is:
16% = CN¥1.2b ÷ CN¥7.2b (Based on the trailing twelve months to December 2023).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.16.
What Is The Relationship Between ROE And 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 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.
Tonghua Dongbao Pharmaceutical's Earnings Growth And 16% ROE
To start with, Tonghua Dongbao Pharmaceutical's ROE looks acceptable. Especially when compared to the industry average of 8.1% the company's ROE looks pretty impressive. Probably as a result of this, Tonghua Dongbao Pharmaceutical was able to see a decent growth of 11% over the last five years.
We then performed a comparison between Tonghua Dongbao Pharmaceutical's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 10% in the same 5-year period.
Earnings growth is a huge factor in stock valuation. 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. If you're wondering about Tonghua Dongbao Pharmaceutical's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Tonghua Dongbao Pharmaceutical Using Its Retained Earnings Effectively?
Tonghua Dongbao Pharmaceutical has a healthy combination of a moderate three-year median payout ratio of 47% (or a retention ratio of 53%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.
Moreover, Tonghua Dongbao 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. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 27% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.
Summary
Overall, we are quite pleased with Tonghua Dongbao Pharmaceutical's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. 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.