Stock Analysis

Vita Life Sciences Limited (ASX:VLS) On An Uptrend: Could Fundamentals Be Driving The Stock?

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ASX:VLS
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Vita Life Sciences' (ASX:VLS) stock up by 8.5% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to investigate if the company's decent financials had a hand to play in the recent price move. Specifically, we decided to study Vita Life Sciences' ROE in this article.

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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

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How To Calculate Return On Equity?

ROE can be calculated by using the formula:

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

So, based on the above formula, the ROE for Vita Life Sciences is:

22% = AU$5.1m ÷ AU$23m (Based on the trailing twelve months to June 2020).

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$0.22 in profit.

What Has ROE Got To Do With 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.

Vita Life Sciences' Earnings Growth And 22% ROE

To start with, Vita Life Sciences' ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 17%. For this reason, Vita Life Sciences' five year net income decline of 7.3% raises the question as to why the high ROE didn't translate into earnings growth. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. These include low earnings retention or poor allocation of capital.

From the 7.3% decline reported by the industry in the same period, we infer that Vita Life Sciences and its industry are both shrinking at a similar rate.

past-earnings-growth
ASX:VLS Past Earnings Growth February 18th 2021

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. This then helps them determine if the stock is placed for a bright or bleak future. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Vita Life Sciences is trading on a high P/E or a low P/E, relative to its industry.

Is Vita Life Sciences Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 72% (implying that 28% of the profits are retained), most of Vita Life Sciences' profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. Our risks dashboard should have the 3 risks we have identified for Vita Life Sciences.

Moreover, Vita Life Sciences has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Conclusion

On the whole, we do feel that Vita Life Sciences has some positive attributes. However, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. So far, we've only made a quick discussion around the company's earnings growth. So it may be worth checking this free detailed graph of Vita Life Sciences' past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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