Fusen Pharmaceutical (HKG:1652) has had a rough three months with its share price down 40%. We, however decided to study the company’s financials to determine if they have got anything to do with the price decline. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company’s financial performance. Particularly, we will be paying attention to Fusen Pharmaceutical’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. In simpler terms, it measures the profitability of a company in relation to shareholder’s equity.
See our latest analysis for Fusen Pharmaceutical
How Do You 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 Fusen Pharmaceutical is:
7.7% = CN¥52m ÷ CN¥682m (Based on the trailing twelve months to December 2019).
The ‘return’ refers to a company’s earnings over the last year. Another way to think of that is that for every HK$1 worth of equity, the company was able to earn HK$0.08 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learnt 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.
Fusen Pharmaceutical’s Earnings Growth And 7.7% ROE
On the face of it, Fusen Pharmaceutical’s ROE is not much to talk about. A quick further study shows that the company’s ROE doesn’t compare favorably to the industry average of 11% either. Therefore, Fusen Pharmaceutical’s flat earnings over the past five years can possibly be explained by the low ROE amongst other factors.
Next, on comparing with the industry net income growth, we found that Fusen Pharmaceutical’s reported growth was lower than the industry growth of 15% in the same period, which is not something we like to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock’s future looks promising or ominous. If you’re wondering about Fusen Pharmaceutical’s’s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Fusen Pharmaceutical Making Efficient Use Of Its Profits?
Fusen Pharmaceutical’s low three-year median payout ratio of 9.3%, (meaning the company retains91% of profits) should mean that the company is retaining most of its earnings and consequently, should see higher growth than it has reported.
Only recently, Fusen Pharmaceutical started paying a dividend. This means that the management might have concluded that its shareholders prefer dividends over earnings growth.
Overall, we have mixed feelings about Fusen Pharmaceutical. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Up till now, we’ve only made a short study of the company’s growth data. So it may be worth checking this free detailed graph of Fusen Pharmaceutical’s past earnings, as well as revenue and cash flows to get a deeper insight into the company’s performance.
If you spot an error that warrants correction, please contact the editor at [email protected] This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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