Is Weakness In Raia Drogasil S.A. (BVMF:RADL3) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

It is hard to get excited after looking at Raia Drogasil's (BVMF:RADL3) recent performance, when its stock has declined 12% over the past three months. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Raia Drogasil's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Raia Drogasil

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 Raia Drogasil is:

18% = R$1.1b ÷ R$6.3b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. That means that for every R$1 worth of shareholders' equity, the company generated R$0.18 in profit.

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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Raia Drogasil's Earnings Growth And 18% ROE

On the face of it, Raia Drogasil's ROE is not much to talk about. Although a closer study shows that the company's ROE is higher than the industry average of 8.7% which we definitely can't overlook. This probably goes some way in explaining Raia Drogasil's moderate 12% growth over the past five years amongst other factors. That being said, the company does have a slightly low ROE to begin with, just that it is higher than the industry average. Therefore, the growth in earnings could also be the result of other factors. For example, it is possible that the broader industry is going through a high growth phase, or that the company has a low payout ratio.

As a next step, we compared Raia Drogasil's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 8.2%.

Earnings growth is a huge factor in stock valuation. 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. Is Raia Drogasil fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Raia Drogasil Using Its Retained Earnings Effectively?

Raia Drogasil's three-year median payout ratio to shareholders is 18% (implying that it retains 82% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Moreover, Raia Drogasil is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 35% over the next three years. Regardless, the future ROE for Raia Drogasil is speculated to rise to 23% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.

Summary

Overall, we are quite pleased with Raia Drogasil's performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.