Grifols (BME:GRF) has had a great run on the share market with its stock up by a significant 10.0% over the last month. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company’s key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study Grifols’ ROE in this article.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
View our latest analysis for Grifols
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 Grifols is:
10% = €738m ÷ €7.2b (Based on the trailing twelve months to March 2020).
The ‘return’ is the profit over the last twelve months. Another way to think of that is that for every €1 worth of equity, the company was able to earn €0.10 in profit.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company’s future earnings. 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. 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.
Grifols’ Earnings Growth And 10% ROE
To start with, Grifols’ ROE looks acceptable. Even so, when compared with the average industry ROE of 14%, we aren’t very excited. Although, we can see that Grifols saw a modest net income growth of 5.0% over the past five years. Therefore, the growth in earnings could probably have been caused by other variables. For instance, the company has a low payout ratio or is being managed efficiently. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this also does lend some color to the fairly high earnings growth seen by the company.
As a next step, we compared Grifols’ net income growth with the industry and were disappointed to see that the company’s growth is lower than the industry average growth of 29% in the same period.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Grifols fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Grifols Making Efficient Use Of Its Profits?
Grifols has a three-year median payout ratio of 39%, which implies that it retains the remaining 61% 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.
Moreover, Grifols 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. 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 36%. Regardless, the future ROE for Grifols is predicted to rise to 17% despite there being not much change expected in its payout ratio.
Summary
On the whole, we do feel that Grifols has some positive attributes. Specifically, we like that the company is reinvesting a huge chunk of its profits at a respectable rate of return. This of course has caused the company to see a good amount of growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company’s earnings are expected to accelerate. Are these analysts expectations based on the broad expectations for the industry, or on the company’s fundamentals? Click here to be taken to our analyst’s forecasts page for the company.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.
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