With its stock down 17% over the past three months, it is easy to disregard Blau Farmacêutica (BVMF:BLAU3). 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 Blau Farmacêutica's ROE today.
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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
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 Blau Farmacêutica is:
17% = R$309m ÷ R$1.9b (Based on the trailing twelve months to June 2023).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each R$1 of shareholders' capital it has, the company made R$0.17 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Blau Farmacêutica's Earnings Growth And 17% ROE
At first glance, Blau Farmacêutica's ROE doesn't look very promising. However, the fact that the its ROE is quite higher to the industry average of 8.6% doesn't go unnoticed by us. Especially when you consider Blau Farmacêutica's exceptional 22% net income growth over the past five years. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. So, there might well be other reasons for the earnings to grow. 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 Blau Farmacêutica'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 14%.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is BLAU3 fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Blau Farmacêutica Making Efficient Use Of Its Profits?
Blau Farmacêutica's three-year median payout ratio to shareholders is 22%, which is quite low. This implies that the company is retaining 78% of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.
Along with seeing a growth in earnings, Blau Farmacêutica only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 21%. Accordingly, forecasts suggest that Blau Farmacêutica's future ROE will be 17% which is again, similar to the current ROE.
In total, we are pretty happy with Blau Farmacêutica'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 growth is expected to slow down. 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.