Is Sonic Healthcare Limited's (ASX:SHL) Recent Stock Performance Tethered To Its Strong Fundamentals?

Sonic Healthcare's (ASX:SHL) stock is up by a considerable 19% over the past month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Sonic Healthcare's 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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Sonic Healthcare

How Is ROE Calculated?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Sonic Healthcare is:

14% = AU$1.1b ÷ AU$7.6b (Based on the trailing twelve months to December 2022).

The 'return' is the income the business earned over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.14.

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.

Sonic Healthcare's Earnings Growth And 14% ROE

To begin with, Sonic Healthcare seems to have a respectable ROE. On comparing with the average industry ROE of 6.3% the company's ROE looks pretty remarkable. Probably as a result of this, Sonic Healthcare was able to see an impressive net income growth of 27% over the last five years. We reckon that there could also be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that Sonic Healthcare's growth is quite high when compared to the industry average growth of 11% in the same period, which is great to see.

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. Has the market priced in the future outlook for SHL? You can find out in our latest intrinsic value infographic research report.

Is Sonic Healthcare Making Efficient Use Of Its Profits?

The three-year median payout ratio for Sonic Healthcare is 39%, which is moderately low. The company is retaining the remaining 61%. By the looks of it, the dividend is well covered and Sonic Healthcare is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Additionally, Sonic Healthcare 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's future payout ratio is expected to rise to 71% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 9.8%, over the same period.

Summary

On the whole, we feel that Sonic Healthcare's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. 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.