Zydus Lifesciences Limited's (NSE:ZYDUSLIFE) Stock Is Going Strong: Have Financials A Role To Play?

Zydus Lifesciences (NSE:ZYDUSLIFE) has had a great run on the share market with its stock up by a significant 33% over the last three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on Zydus Lifesciences' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Zydus Lifesciences

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Zydus Lifesciences is:

15% = ₹31b ÷ ₹209b (Based on the trailing twelve months to December 2023).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.15 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

Zydus Lifesciences' Earnings Growth And 15% ROE

On the face of it, Zydus Lifesciences' ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 13%. Having said that, Zydus Lifesciences has shown a modest net income growth of 11% over the past five years. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Zydus Lifesciences' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 15% in the same period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. One 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 prospects. So, you may want to check if Zydus Lifesciences is trading on a high P/E or a low P/E, relative to its industry.

Is Zydus Lifesciences Making Efficient Use Of Its Profits?

Zydus Lifesciences has a low three-year median payout ratio of 14%, meaning that the company retains the remaining 86% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Moreover, Zydus Lifesciences is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 17%. Accordingly, forecasts suggest that Zydus Lifesciences' future ROE will be 13% which is again, similar to the current ROE.

Conclusion

In total, it does look like Zydus Lifesciences has some positive aspects to its business. Specifically, its fairly high earnings growth number, which no doubt was backed by the company's high earnings retention. Still, the low ROE means that all that reinvestment is not reaping a lot of benefit to the investors. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.