Should Weakness in MERCK Kommanditgesellschaft auf Aktien's (ETR:MRK) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

It is hard to get excited after looking at MERCK Kommanditgesellschaft auf Aktien's (ETR:MRK) recent performance, when its stock has declined 3.2% over the past week. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on MERCK Kommanditgesellschaft auf Aktien's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for MERCK Kommanditgesellschaft auf Aktien

How To Calculate Return On Equity?

Return on equity 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 Kommanditgesellschaft auf Aktien is:

10% = €1.9b ÷ €18b (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. One way to conceptualize this is that for each €1 of shareholders' capital it has, the company made €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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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 Kommanditgesellschaft auf Aktien's Earnings Growth And 10% ROE

At first glance, MERCK Kommanditgesellschaft auf Aktien seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 10%. Given the circumstances, we can't help but wonder why MERCK Kommanditgesellschaft auf Aktien 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. These include low earnings retention or poor allocation of capital.

We then compared MERCK Kommanditgesellschaft auf Aktien's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 5.2% in the same period, which is a bit concerning.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 MRK? You can find out in our latest intrinsic value infographic research report.

Is MERCK Kommanditgesellschaft auf Aktien Efficiently Re-investing Its Profits?

In spite of a normal three-year median payout ratio of 36% (or a retention ratio of 64%), MERCK Kommanditgesellschaft auf Aktien hasn't seen much growth in its earnings. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, MERCK Kommanditgesellschaft auf Aktien 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 19% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.

Conclusion

Overall, we feel that MERCK Kommanditgesellschaft auf Aktien certainly does have some positive factors to consider. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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. 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.
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