Galenica AG (VTX:GALE) Stock's Been Sliding But Fundamentals Look Decent: Will The Market Correct The Share Price In The Future?

It is hard to get excited after looking at Galenica's (VTX:GALE) recent performance, when its stock has declined 5.4% over the past three months. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Galenica's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Galenica

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 Galenica is:

11% = CHF166m ÷ CHF1.5b (Based on the trailing twelve months to December 2023).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every CHF1 worth of equity, the company was able to earn CHF0.11 in profit.

What Is The Relationship Between ROE And 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.

A Side By Side comparison of Galenica's Earnings Growth And 11% ROE

At first glance, Galenica seems to have a decent ROE. On comparing with the average industry ROE of 8.2% the company's ROE looks pretty remarkable. Despite this, Galenica's five year net income growth was quite low averaging at only 3.3%. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

As a next step, we compared Galenica's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 12% in the same period.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for GALE? You can find out in our latest intrinsic value infographic research report.

Is Galenica Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 62% (or a retention ratio of 38%), most of Galenica's profits are being paid to shareholders. This definitely contributes to the low earnings growth seen by the company.

Moreover, Galenica has been paying dividends for six years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 47% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.

Summary

On the whole, we do feel that Galenica has some positive attributes. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. 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.