Sonic Healthcare Limited's (ASX:SHL) Stock Been Rising: Are Strong Financials Guiding The Market?

Sonic Healthcare's (ASX:SHL) stock is up by 9.4% 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 Sonic Healthcare's ROE.

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.

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:

8.9% = AU$708m ÷ AU$7.9b (Based on the trailing twelve months to June 2023).

The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.09 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Sonic Healthcare's Earnings Growth And 8.9% ROE

When you first look at it, Sonic Healthcare's ROE doesn't look that attractive. Although a closer study shows that the company's ROE is higher than the industry average of 6.9% which we definitely can't overlook. Consequently, this likely laid the ground for the decent growth of 20% seen over the past five years by Sonic Healthcare. That being said, the company does have a slightly low ROE to begin with, just that it is higher than the industry average. So there might well be other reasons for the earnings to grow. Such as- high earnings retention or the company belonging to a high growth industry.

We then compared Sonic Healthcare's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 2.4% in the same 5-year period.

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. This then helps them determine if the stock is placed for a bright or bleak future. What is SHL worth today? The intrinsic value infographic in our free research report helps visualize whether SHL is currently mispriced by the market.

Is Sonic Healthcare Efficiently Re-investing Its Profits?

With a three-year median payout ratio of 39% (implying that the company retains 61% of its profits), it seems that Sonic Healthcare is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

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. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 69% over the next three years. However, the company's ROE is not expected to change by much despite the higher expected payout ratio.

Conclusion

On the whole, we feel that Sonic Healthcare's performance has been quite good. Specifically, we like that it has been reinvesting a high portion of its profits at a moderate rate of return, resulting in earnings expansion. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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. 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.