Novartis AG's (VTX:NOVN) Stock On An Uptrend: Could Fundamentals Be Driving The Momentum?

Novartis' (VTX:NOVN) stock is up by a considerable 10% over the past month. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study Novartis' ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Novartis

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 Novartis is:

21% = US$8.2b ÷ US$38b (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. Another way to think of that is that for every CHF1 worth of equity, the company was able to earn CHF0.21 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. 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. 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.

Novartis' Earnings Growth And 21% ROE

First thing first, we like that Novartis has an impressive ROE. Additionally, the company's ROE is higher compared to the industry average of 7.3% which is quite remarkable. Probably as a result of this, Novartis was able to see a decent net income growth of 6.4% over the last five years.

As a next step, we compared Novartis' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 13% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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. 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?

While Novartis has a three-year median payout ratio of 89% (which means it retains 11% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.

Additionally, Novartis has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 51% over the next three years. The fact that the company's ROE is expected to rise to 44% over the same period is explained by the drop in the payout ratio.

Conclusion

On the whole, we do feel that Novartis has some positive attributes. Its earnings have grown respectably as we saw earlier, which was likely due to the company reinvesting its earnings at a pretty high rate of return. However, given the high ROE, we do think that the company is reinvesting a small portion of its profits. This could likely be preventing the company from growing to its full extent. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.