Is Merck KGaA's (ETR:MRK) Latest Stock Performance Being Led By Its Strong Fundamentals?

Merck KGaA's (ETR:MRK) stock up by 3.4% over the past week. Given its impressive performance, we decided to study the company's key financial indicators as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Merck KGaA's ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Merck KGaA

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 Merck KGaA is:

10% = €2.9b ÷ €28b (Based on the trailing twelve months to September 2023).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every €1 worth of equity, the company was able to earn €0.10 in profit.

What Has ROE Got To Do With Earnings Growth?

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

A Side By Side comparison of Merck KGaA's Earnings Growth And 10% ROE

To start with, Merck KGaA's ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 12%. This certainly adds some context to Merck KGaA's exceptional 23% net income growth seen over the past five years. We reckon that there could also be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Merck KGaA'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 13%.

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for MRK? You can find out in our latest intrinsic value infographic research report.

Is Merck KGaA Efficiently Re-investing Its Profits?

Merck KGaA's three-year median payout ratio is a pretty moderate 27%, meaning the company retains 73% of its income. By the looks of it, the dividend is well covered and Merck KGaA is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Besides, Merck KGaA has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with 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 23%. Regardless, the future ROE for Merck KGaA is predicted to rise to 13% despite there being not much change expected in its payout ratio.

Summary

Overall, we are quite pleased with Merck KGaA's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high 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. 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.