Raia Drogasil S.A.'s (BVMF:RADL3) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

It is hard to get excited after looking at Raia Drogasil's (BVMF:RADL3) recent performance, when its stock has declined 4.6% over the past week. 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 key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Raia Drogasil

How Is ROE Calculated?

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:

19% = R$1.1b ÷ R$5.8b (Based on the trailing twelve months to September 2023).

The 'return' is the profit over the last twelve months. That means that for every R$1 worth of shareholders' equity, the company generated R$0.19 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. 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 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 19% ROE

To start with, Raia Drogasil's ROE looks acceptable. Especially when compared to the industry average of 11% the company's ROE looks pretty impressive. This probably laid the ground for Raia Drogasil's moderate 14% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that Raia Drogasil's growth is quite high when compared to the industry average growth of 9.2% 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. Doing so will help them establish if the stock's future looks promising or ominous. 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 Raia Drogasil is trading on a high P/E or a low P/E, relative to its industry.

Is Raia Drogasil Making Efficient Use Of Its Profits?

In Raia Drogasil's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 14% (or a retention ratio of 86%), which suggests that the company is investing most of its profits to grow its business.

Besides, Raia Drogasil has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 56% over the next three years. Regardless, the future ROE for Raia Drogasil is speculated to rise to 28% 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. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.