Is Merck KGaA's (ETR:MRK) Stock's Recent Performance Being Led By Its Attractive Financial Prospects?

Most readers would already be aware that Merck KGaA's (ETR:MRK) stock increased significantly by 10% over the past month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Merck KGaA's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Merck KGaA

How Is ROE Calculated?

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 Merck KGaA is:

9.2% = €2.6b ÷ €29b (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. So, this means that for every €1 of its shareholder's investments, the company generates a profit of €0.09.

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. 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. 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.

Merck KGaA's Earnings Growth And 9.2% ROE

At first glance, Merck KGaA seems to have a decent ROE. Even when compared to the industry average of 9.2% the company's ROE looks quite decent. Consequently, this likely laid the ground for the decent growth of 16% seen over the past five years by Merck KGaA.

Next, on comparing with the industry net income growth, we found that Merck KGaA's growth is quite high when compared to the industry average growth of 8.4% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. What is MRK worth today? The intrinsic value infographic in our free research report helps visualize whether MRK is currently mispriced by the market.

Is Merck KGaA Efficiently Re-investing Its Profits?

With a three-year median payout ratio of 29% (implying that the company retains 71% of its profits), it seems that Merck KGaA is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Additionally, Merck KGaA 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 23%. However, Merck KGaA's ROE is predicted to rise to 14% despite there being no anticipated change in its payout ratio.

Conclusion

In total, we are pretty happy with Merck KGaA's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.