Novartis AG's (VTX:NOVN) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

Novartis (VTX:NOVN) has had a great run on the share market with its stock up by a significant 12% over the last month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Novartis' 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 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 To Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Novartis is:

32% = US$14b ÷ US$42b (Based on the trailing twelve months to June 2025).

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 CHF0.32 in profit.

Check out our latest analysis for Novartis

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Novartis' Earnings Growth And 32% ROE

Firstly, we acknowledge that Novartis has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 12% also doesn't go unnoticed by us. Given the circumstances, we can't help but wonder why Novartis saw little to no growth in the past five years. So, there could be some other aspects that could potentially be preventing the company from growing. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

We then compared Novartis' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 9.4% in the same 5-year period, which is a bit concerning.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Novartis is trading on a high P/E or a low P/E, relative to its industry.

Is Novartis Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 80% (implying that the company keeps only 20% of its income) of its business to reinvest into its business), most of Novartis' profits are being paid to shareholders, which explains the absence of growth in earnings.

Additionally, Novartis has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 44% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.

Conclusion

In total, it does look like Novartis has some positive aspects to its business. However, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.