With An ROE Of 3.9%, Can Lansen Pharmaceutical Holdings Limited (HKG:503) Catch Up To The Industry?
I am writing today to help inform people who are new to the stock market and want to begin learning the link between company’s fundamentals and stock market performance.
Lansen Pharmaceutical Holdings Limited (HKG:503) delivered a less impressive 3.9% ROE over the past year, compared to the 13.5% return generated by its industry. Though 503’s recent performance is underwhelming, it is useful to understand what ROE is made up of and how it should be interpreted. Knowing these components can change your views on 503’s below-average returns. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of 503’s returns. Let me show you what I mean by this.
View our latest analysis for Lansen Pharmaceutical Holdings
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs Lansen Pharmaceutical Holdings’s profit against the level of its shareholders’ equity. An ROE of 3.9% implies HK$0.039 returned on every HK$1 invested. In most cases, a higher ROE is preferred; however, there are many other factors we must consider prior to making any investment decisions.
Return on Equity = Net Profit ÷ Shareholders Equity
Returns are usually compared to costs to measure the efficiency of capital. Lansen Pharmaceutical Holdings’s cost of equity is 11.1%. Given a discrepancy of -7.3% between return and cost, this indicated that Lansen Pharmaceutical Holdings may be paying more for its capital than what it’s generating in return. ROE can be broken down into three different ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
Dupont Formula
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. The other component, asset turnover, illustrates how much revenue Lansen Pharmaceutical Holdings can make from its asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be inflated by excessive debt, we need to examine Lansen Pharmaceutical Holdings’s debt-to-equity level. Currently the debt-to-equity ratio stands at a reasonable 88.6%, which means its ROE is driven by its ability to grow its profit without a significant debt burden.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Lansen Pharmaceutical Holdings’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. However, ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of returns, which has headroom to increase further. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Lansen Pharmaceutical Holdings, I’ve compiled three essential aspects you should look at:
Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Future Earnings: How does Lansen Pharmaceutical Holdings’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Lansen Pharmaceutical Holdings? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
