With its stock down 3.9% over the past three months, it is easy to disregard Novo Nordisk (CPH:NOVO B). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Novo Nordisk’s ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
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 Novo Nordisk is:
69% = kr.41b ÷ kr.60b (Based on the trailing twelve months to June 2020).
The ‘return’ is the profit over the last twelve months. Another way to think of that is that for every DKK1 worth of equity, the company was able to earn DKK0.69 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we’ve learned that ROE is a measure of a company’s profitability. Depending on how much of these profits the company reinvests or “retains”, and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
Novo Nordisk’s Earnings Growth And 69% ROE
To begin with, Novo Nordisk has a pretty high ROE which is interesting. Additionally, the company’s ROE is higher compared to the industry average of 11% which is quite remarkable. Yet, Novo Nordisk has posted measly growth of 3.4% over the past five years. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn’t been able to do so. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.
Next, on comparing with the industry net income growth, we found that Novo Nordisk’s reported growth was lower than the industry growth of 11% in the same period, which is not something we like to see.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is NOVO B fairly valued? This infographic on the company’s intrinsic value has everything you need to know.
Is Novo Nordisk Using Its Retained Earnings Effectively?
Despite having a normal three-year median payout ratio of 50% (or a retention ratio of 50% over the past three years, Novo Nordisk has seen very little growth in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
Additionally, Novo Nordisk has paid dividends over a period of at least ten years, which means that the company’s management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts’ consensus data, we found that the company is expected to keep paying out approximately 47% of its profits over the next three years. Therefore, the company’s future ROE is also not expected to change by much with analysts predicting an ROE of 69%.
On the whole, we do feel that Novo Nordisk has some positive attributes. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that’s preventing growth. With that said, the latest industry analyst forecasts reveal that the company’s earnings are expected to accelerate. 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. 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.
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