Guangzhou Baiyunshan Pharmaceutical Holdings' (HKG:874) stock is up by a considerable 7.5% over the past week. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Specifically, we decided to study Guangzhou Baiyunshan Pharmaceutical Holdings' 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.

View our latest analysis for Guangzhou Baiyunshan Pharmaceutical Holdings

How To 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 Guangzhou Baiyunshan Pharmaceutical Holdings is:

12% = CN¥4.5b ÷ CN¥36b (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. Another way to think of that is that for every HK$1 worth of equity, the company was able to earn HK$0.12 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company's earnings growth potential. 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 Guangzhou Baiyunshan Pharmaceutical Holdings' Earnings Growth And 12% ROE

At first glance, Guangzhou Baiyunshan Pharmaceutical Holdings seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 9.6%. Despite this, Guangzhou Baiyunshan Pharmaceutical Holdings' five year net income growth was quite low averaging at only 4.7%. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn't been able to do so. 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.

Next, on comparing with the industry net income growth, we found that Guangzhou Baiyunshan Pharmaceutical Holdings' reported growth was lower than the industry growth of 11% over the last few years, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for 874? You can find out in our latest intrinsic value infographic research report.

Is Guangzhou Baiyunshan Pharmaceutical Holdings Making Efficient Use Of Its Profits?

Despite having a normal three-year median payout ratio of 29% (or a retention ratio of 71% over the past three years, Guangzhou Baiyunshan Pharmaceutical Holdings has seen very little growth in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Moreover, Guangzhou Baiyunshan Pharmaceutical Holdings has been paying dividends for nine years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 27% of its profits over the next three years. Accordingly, forecasts suggest that Guangzhou Baiyunshan Pharmaceutical Holdings' future ROE will be 11% which is again, similar to the current ROE.

Conclusion

Overall, we feel that Guangzhou Baiyunshan Pharmaceutical Holdings certainly does have some positive factors to consider. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.