Will Weakness in Carl Zeiss Meditec AG's (ETR:AFX) Stock Prove Temporary Given Strong Fundamentals?

Carl Zeiss Meditec (ETR:AFX) has had a rough month with its share price down 11%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Carl Zeiss Meditec's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Carl Zeiss Meditec

How Do You Calculate Return On Equity?

ROE can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Carl Zeiss Meditec is:

13% = €278m ÷ €2.2b (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 €1 of shareholders' capital it has, the company made €0.13 in profit.

Why Is ROE Important For 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Carl Zeiss Meditec's Earnings Growth And 13% ROE

At first glance, Carl Zeiss Meditec seems to have a decent ROE. On comparing with the average industry ROE of 8.3% the company's ROE looks pretty remarkable. This probably laid the ground for Carl Zeiss Meditec's moderate 19% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that Carl Zeiss Meditec's growth is quite high when compared to the industry average growth of 4.3% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. What is AFX worth today? The intrinsic value infographic in our free research report helps visualize whether AFX is currently mispriced by the market.

Is Carl Zeiss Meditec Using Its Retained Earnings Effectively?

Carl Zeiss Meditec has a three-year median payout ratio of 34%, which implies that it retains the remaining 66% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Besides, Carl Zeiss Meditec has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 33% of its profits over the next three years. As a result, Carl Zeiss Meditec's ROE is not expected to change by much either, which we inferred from the analyst estimate of 14% for future ROE.

Conclusion

In total, we are pretty happy with Carl Zeiss Meditec's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.