Are Robust Financials Driving The Recent Rally In Pro Medicus Limited's (ASX:PME) Stock?

Most readers would already be aware that Pro Medicus' (ASX:PME) stock increased significantly by 16% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Pro Medicus' ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Pro Medicus

How Is ROE Calculated?

The 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 Pro Medicus is:

44% = AU$70m ÷ AU$159m (Based on the trailing twelve months to December 2023).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.44 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

A Side By Side comparison of Pro Medicus' Earnings Growth And 44% ROE

Firstly, we acknowledge that Pro Medicus has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 11% which is quite remarkable. As a result, Pro Medicus' exceptional 29% net income growth seen over the past five years, doesn't come as a surprise.

We then compared Pro Medicus' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 15% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. 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. Is Pro Medicus fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Pro Medicus Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 51% (implying that it keeps only 49% of profits) for Pro Medicus suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.

Additionally, Pro Medicus has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 52%. Accordingly, forecasts suggest that Pro Medicus' future ROE will be 45% which is again, similar to the current ROE.

Conclusion

On the whole, we feel that Pro Medicus' performance has been quite good. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.

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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.