Has Nanosonics Limited's (ASX:NAN) Impressive Stock Performance Got Anything to Do With Its Fundamentals?

Nanosonics' (ASX:NAN) stock is up by a considerable 6.8% over the past week. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Nanosonics' 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Nanosonics

How To Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for Nanosonics is:

12% = AU$20m ÷ AU$164m (Based on the trailing twelve months to June 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$0.12 in profit.

What Is The Relationship Between ROE And 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. 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 Nanosonics' Earnings Growth And 12% ROE

At first glance, Nanosonics seems to have a decent ROE. On comparing with the average industry ROE of 9.3% the company's ROE looks pretty remarkable. Despite this, Nanosonics' five year net income growth was quite low averaging at only 3.3%. That's a bit unexpected from a company which has such a high rate of return. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.

We then compared Nanosonics' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 5.8% in the same 5-year period, which is a bit concerning.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for NAN? You can find out in our latest intrinsic value infographic research report.

Is Nanosonics Making Efficient Use Of Its Profits?

Nanosonics doesn't pay any dividend, meaning that potentially all of its profits are being reinvested in the business. However, this doesn't explain the low earnings growth the company has seen. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Conclusion

On the whole, we do feel that Nanosonics has some positive attributes. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.