Most readers would already be aware that Yantai Dongcheng Pharmaceutical GroupLtd's (SZSE:002675) stock increased significantly by 11% over the past three months. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. Specifically, we decided to study Yantai Dongcheng Pharmaceutical GroupLtd's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How Is ROE Calculated?

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 Yantai Dongcheng Pharmaceutical GroupLtd is:

1.2% = CN¥65m ÷ CN¥5.5b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.01 in profit.

Why Is ROE Important For 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 Yantai Dongcheng Pharmaceutical GroupLtd's Earnings Growth And 1.2% ROE

It is hard to argue that Yantai Dongcheng Pharmaceutical GroupLtd's ROE is much good in and of itself. Not just that, even compared to the industry average of 6.0%, the company's ROE is entirely unremarkable. Therefore, it might not be wrong to say that the five year net income decline of 7.0% seen by Yantai Dongcheng Pharmaceutical GroupLtd was possibly a result of it having a 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 Yantai Dongcheng Pharmaceutical GroupLtd's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 5.9% in the same period. This is quite worrisome.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is Yantai Dongcheng Pharmaceutical GroupLtd fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Yantai Dongcheng Pharmaceutical GroupLtd Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 55% (implying that 45% of the profits are retained), most of Yantai Dongcheng Pharmaceutical GroupLtd's profits are being paid to shareholders, which explains the company's shrinking earnings. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. To know the 2 risks we have identified for Yantai Dongcheng Pharmaceutical GroupLtd visit our risks dashboard for free.

In addition, Yantai Dongcheng Pharmaceutical GroupLtd 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 50%. However, Yantai Dongcheng Pharmaceutical GroupLtd's ROE is predicted to rise to 7.6% despite there being no anticipated change in its payout ratio.

Summary

In total, we would have a hard think before deciding on any investment action concerning Yantai Dongcheng Pharmaceutical GroupLtd. 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. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.