Will Weakness in Raia Drogasil S.A.'s (BVMF:RADL3) Stock Prove Temporary Given Strong Fundamentals?

With its stock down 22% over the past three months, it is easy to disregard Raia Drogasil (BVMF:RADL3). 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. In this article, we decided to focus on Raia Drogasil's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. 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 Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Raia Drogasil is:

18% = R$1.2b ÷ R$6.5b (Based on the trailing twelve months to March 2025).

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.

View our latest analysis for Raia Drogasil

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. 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.

Raia Drogasil's Earnings Growth And 18% ROE

On the face of it, Raia Drogasil's ROE is not much to talk about. However, the fact that the company's ROE is higher than the average industry ROE of 11%, is definitely interesting. Consequently, this likely laid the ground for the decent growth of 15% seen over the past five years by Raia Drogasil. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. Hence there might be some other aspects that are causing earnings to grow. E.g the company has a low payout ratio or could belong to a high growth industry.

We then performed a comparison between Raia Drogasil's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 13% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Raia Drogasil's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Raia Drogasil Using Its Retained Earnings Effectively?

In Raia Drogasil's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 20% (or a retention ratio of 80%), which suggests that the company is investing most of its profits 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 47% over the next three years. Still, forecasts suggest that Raia Drogasil's future ROE will rise to 22% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.

Summary

Overall, we are quite pleased with Raia Drogasil's performance. Specifically, we like that it has been reinvesting a high portion of its profits at a moderate rate of return, resulting in earnings expansion. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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.