Do Its Financials Have Any Role To Play In Driving Novozymes A/S' (CPH:NZYM B) Stock Up Recently?

Most readers would already be aware that Novozymes' (CPH:NZYM B) stock increased significantly by 12% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Novozymes' ROE today.

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.

View our latest analysis for Novozymes

How Do You 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 Novozymes is:

25% = kr.2.8b ÷ kr.11b (Based on the trailing twelve months to December 2020).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every DKK1 worth of equity, the company was able to earn DKK0.25 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Novozymes' Earnings Growth And 25% ROE

Firstly, we acknowledge that Novozymes has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 11% which is quite remarkable. However, we are curious as to how the high returns still resulted in a flat growth for Novozymes in the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

Next, on comparing with the industry net income growth, we found that Novozymes' reported growth was lower than the industry growth of 8.6% in the same period, which is not something we like to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Novozymes is trading on a high P/E or a low P/E, relative to its industry.

Is Novozymes Efficiently Re-investing Its Profits?

Despite having a normal three-year median payout ratio of 46% (implying that the company keeps 54% of its income) over the last three years, Novozymes has seen a negligible amount of growth in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, Novozymes 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. 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 45%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 29%.

Conclusion

In total, it does look like Novozymes has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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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