It is hard to get excited after looking at KPC PharmaceuticalsInc's (SHSE:600422) recent performance, when its stock has declined 33% over the past three months. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. In this article, we decided to focus on KPC PharmaceuticalsInc's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Is ROE Calculated?

Return on equity 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 KPC PharmaceuticalsInc is:

8.2% = CN¥457m ÷ CN¥5.6b (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.08 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 KPC PharmaceuticalsInc's Earnings Growth And 8.2% ROE

When you first look at it, KPC PharmaceuticalsInc's ROE doesn't look that attractive. However, its ROE is similar to the industry average of 7.6%, so we won't completely dismiss the company. However, KPC PharmaceuticalsInc has seen a flattish net income growth over the past five years, which is not saying much. Remember, the company's ROE is not particularly great to begin with. Hence, this provides some context to the flat earnings growth seen by the company.

Next, on comparing with the industry net income growth, we found that the industry grew its earnings by 9.0% over the last few years.

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). This then helps them determine if the stock is placed for a bright or bleak future. What is 600422 worth today? The intrinsic value infographic in our free research report helps visualize whether 600422 is currently mispriced by the market.

Is KPC PharmaceuticalsInc Efficiently Re-investing Its Profits?

In spite of a normal three-year median payout ratio of 33% (or a retention ratio of 67%), KPC PharmaceuticalsInc hasn't seen much growth in its earnings. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Moreover, KPC PharmaceuticalsInc has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 13% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 12%, over the same period.

Conclusion

On the whole, we feel that the performance shown by KPC PharmaceuticalsInc can be open to many interpretations. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.