Pro Medicus Limited's (ASX:PME) Stock's On An Uptrend: Are Strong Financials Guiding The Market?

Most readers would already be aware that Pro Medicus' (ASX:PME) stock increased significantly by 37% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Pro Medicus' 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.

See our latest analysis for Pro Medicus

How Do You 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 Pro Medicus is:

35% = AU$25m ÷ AU$71m (Based on the trailing twelve months to December 2020).

The 'return' is the profit over the last twelve months. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.35.

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. 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. 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 Pro Medicus' Earnings Growth And 35% ROE

First thing first, we like that Pro Medicus has an impressive ROE. Secondly, even when compared to the industry average of 9.1% the company's ROE is quite impressive. Under the circumstances, Pro Medicus' considerable five year net income growth of 32% was to be expected.

Next, on comparing with the industry net income growth, we found that the growth figure reported by Pro Medicus compares quite favourably to the industry average, which shows a decline of 34% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. If you're wondering about Pro Medicus''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Pro Medicus Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 52% (implying that it keeps only 48% of profits) for Pro Medicus suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.

Additionally, Pro Medicus 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 48%. Still, forecasts suggest that Pro Medicus' future ROE will rise to 46% even though the the company's payout ratio is not expected to change by much.

Conclusion

On the whole, we feel that Pro Medicus' performance has been quite good. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.

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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. 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.
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