Shares of Simcere Pharmaceutical Group (HKG:2096) are up 13% over the past month. Given that the market rewards strong long-term financials, we wonder if this is the case in this case. In particular, we will pay attention to the ROE of Simcere Pharmaceutical Group today.
Return on equity or ROE is an important factor for a shareholder to consider as it tells them how much of their capital is being reinvested. In simple terms, it is used to assess the profitability of a company in relation to its equity.
Check out our latest analysis for Simcere Pharmaceutical Group
How do you calculate return on equity?
The ROE formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for Simcere Pharmaceutical Group is:
23% = CN¥1.5 billion ÷ CN¥6.5 billion (based on the last twelve months to December 2021).
The “yield” is the profit of the last twelve months. One way to conceptualize this is that for every HK$1 of share capital it has, the company has made a profit of HK$0.23.
What does ROE have to do with earnings growth?
So far, we have learned that ROE measures how efficiently a company generates its profits. Depending on how much of those earnings the company reinvests or “keeps”, and how efficiently it does so, we are then able to gauge a company’s earnings growth potential. Generally speaking, all things being equal, companies with high return on equity and earnings retention have a higher growth rate than companies that do not share these attributes.
A side-by-side comparison of Simcere Pharmaceutical Group’s earnings growth and ROE of 23%
For starters, Simcere Pharmaceutical Group has a pretty high ROE, which is interesting. Second, a comparison to the average industry-reported ROE of 11% also does not go unnoticed by us. So, the substantial net income growth of 23% seen by Simcere Pharmaceutical Group over the past five years is not too surprising.
As a next step, we compared Simcere Pharmaceutical Group’s net profit growth with the industry, and fortunately, we found that the growth seen by the company is higher than the industry average growth of 12%.
The basis for attaching value to a company is, to a large extent, linked to the growth of its profits. It is important for an investor to know whether the market has priced in the expected growth (or decline) in the company’s earnings. By doing so, they will get an idea if the stock is headed for clear blue waters or if swampy waters are waiting. A good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings outlook. Thus, you may want to check whether Simcere Pharmaceutical Group is trading on a high P/E or a low P/E, relative to its industry.
Does Simcere Pharmaceutical Group effectively reinvest its profits?
Simcere Pharmaceutical Group has a three-year median payout ratio of 36% (where it retains 64% of its revenue), which is neither too low nor too high. This suggests that its dividend is well covered, and given the strong growth we discussed above, it looks like Simcere Pharmaceutical Group is reinvesting its earnings effectively.
In addition to seeing earnings growth, Simcere Pharmaceutical Group has only recently started paying dividends. It is quite possible that the company was trying to impress its shareholders. Existing analyst estimates suggest the company’s future payout ratio is likely to drop to 0.04% over the next three years. Forecasts still suggest Simcere Pharmaceutical Group’s future ROE will drop to 16%, even though the company’s payout rate is expected to decline. This suggests that other factors could be behind the company’s anticipated decline in ROE.
Overall, we believe Simcere Pharmaceutical Group’s performance has been quite good. In particular, we appreciate the fact that the company is reinvesting heavily in its business, and at a high rate of return. Unsurprisingly, this led to impressive earnings growth. That said, the latest forecasts from industry analysts show that the company’s earnings growth is expected to slow. For more on the company’s future earnings growth forecast, check out this free analyst forecast report for the company to learn more.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.