Are Strong Financial Prospects The Force That Is Driving The Momentum In Neuren Pharmaceuticals Limited's ASX:NEU) Stock?

Neuren Pharmaceuticals (ASX:NEU) has had a great run on the share market with its stock up by a significant 110% over the last three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Particularly, we will be paying attention to Neuren Pharmaceuticals' 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Neuren Pharmaceuticals

How Do You Calculate Return On Equity?

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 Neuren Pharmaceuticals is:

60% = AU$55m ÷ AU$92m (Based on the trailing twelve months to June 2023).

The 'return' is the yearly profit. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.60 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Neuren Pharmaceuticals' Earnings Growth And 60% ROE

Firstly, we acknowledge that Neuren Pharmaceuticals has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 20% also doesn't go unnoticed by us. As a result, Neuren Pharmaceuticals' exceptional 34% net income growth seen over the past five years, doesn't come as a surprise.

We then performed a comparison between Neuren Pharmaceuticals' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 31% in the same 5-year 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). 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 NEU? You can find out in our latest intrinsic value infographic research report.

Is Neuren Pharmaceuticals Making Efficient Use Of Its Profits?

Given that Neuren Pharmaceuticals doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.

Summary

On the whole, we feel that Neuren Pharmaceuticals' performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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.