Will Weakness in Coloplast A/S' (CPH:COLO B) Stock Prove Temporary Given Strong Fundamentals?

Coloplast (CPH:COLO B) has had a rough month with its share price down 9.5%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Coloplast's 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Coloplast

How Do You 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 Coloplast is:

74% = kr.4.2b ÷ kr.5.8b (Based on the trailing twelve months to December 2020).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every DKK1 worth of equity, the company was able to earn DKK0.73 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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 Coloplast's Earnings Growth And 74% ROE

To begin with, Coloplast has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 14% which is quite remarkable. Probably as a result of this, Coloplast was able to see a decent net income growth of 15% over the last five years.

We then compared Coloplast's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 5.3% in the same period.

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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Coloplast's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Coloplast Making Efficient Use Of Its Profits?

Coloplast has a significant three-year median payout ratio of 61%, meaning that it is left with only 39% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Additionally, Coloplast 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 is expected to rise to 87% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 58%, over the same period.

Conclusion

On the whole, we feel that Coloplast's performance has been quite good. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. 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 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. 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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