Beijing Tong Ren Tang Chinese Medicine (HKG:3613) has had a great run on the share market with its stock up by a significant 7.3% over the last week. 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. Particularly, we will be paying attention to Beijing Tong Ren Tang Chinese Medicine’s ROE today.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Do You Calculate Return On Equity?
Tea 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 Beijing Tong Ren Tang Chinese Medicine is:
17% = HK$599m ÷ HK$3.5b (Based on the trailing twelve months to June 2022).
The ‘return’ refers to a company’s earnings over the last year. One way to conceptualize this is that for each HK$1 of shareholders’ capital it has, the company made HK$0.17 in profit.
Why Is ROE Important For Earnings Growth?
So far, we’ve learned that ROE is a measure of a company’s profitability. We now need to evaluate how much profit the company reinvests or “retains” for future growth which then gives us an idea about the growth potential of the company. 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.
Beijing Tong Ren Tang Chinese Medicine’s Earnings Growth And 17% ROE
To start with, Beijing Tong Ren Tang Chinese Medicine’s ROE looks acceptable. Especially when compared to the industry average of 10% the company’s ROE looks pretty impressive. However, for some reason, the higher returns aren’t reflected in Beijing Tong Ren Tang Chinese Medicine’s meagre five year net income growth average of 2.7%. That’s a bit unexpected from a company which has such a high rate of return. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
Next, on comparing with the industry net income growth, we found that Beijing Tong Ren Tang Chinese Medicine’s reported growth was lower than the industry growth of 8.8% in the same period, which is not something we like to see.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you’re wondering about Beijing Tong Ren Tang Chinese Medicine’s valuation, check out this gauge of its price-to-earnings ratioas compared to its industry.
Is Beijing Tong Ren Tang Chinese Medicine Using Its Retained Earnings Effectively?
Despite having a moderate three-year median payout ratio of 37% (implying that the company retains the remaining 63% of its income), Beijing Tong Ren Tang Chinese Medicine’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.
Moreover, Beijing Tong Ren Tang Chinese Medicine 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.
Overall, we feel that Beijing Tong Ren Tang Chinese Medicine certainly does have some positive factors to consider. 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. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the company’s future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
Valuation is complex, but we’re helping make it simple.
Find out whether Beijing Tong Ren Tang Chinese Medicine is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.
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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.