Cochlear Limited's (ASX:COH) Stock's On An Uptrend: Are Strong Financials Guiding The Market?

Cochlear's (ASX:COH) stock is up by a considerable 21% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Particularly, we will be paying attention to Cochlear's ROE today.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Cochlear

How To 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 Cochlear is:

20% = AU$350m ÷ AU$1.8b (Based on the trailing twelve months to December 2023).

The 'return' refers to a company's earnings over the last year. That means that for every A$1 worth of shareholders' equity, the company generated A$0.20 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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Cochlear's Earnings Growth And 20% ROE

To begin with, Cochlear seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 7.7%. This certainly adds some context to Cochlear's decent 14% net income growth seen over the past five years.

As a next step, we compared Cochlear's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 5.6%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Cochlear's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Cochlear Making Efficient Use Of Its Profits?

Cochlear has a significant three-year median payout ratio of 72%, meaning that it is left with only 28% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Additionally, Cochlear 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 69% of its profits over the next three years. Still, forecasts suggest that Cochlear's future ROE will rise to 24% even though the the company's payout ratio is not expected to change by much.

Conclusion

In total, we are pretty happy with Cochlear's performance. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. 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. 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.