Is H. Lundbeck A/S' (CPH:HLUN A) Recent Stock Performance Influenced By Its Fundamentals In Any Way?

H. Lundbeck's (CPH:HLUN A) stock is up by a considerable 14% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Specifically, we decided to study H. Lundbeck'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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for H. Lundbeck

How To Calculate Return On Equity?

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 H. Lundbeck is:

9.2% = kr.1.9b ÷ kr.21b (Based on the trailing twelve months to December 2022).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each DKK1 of shareholders' capital it has, the company made DKK0.09 in profit.

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. 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.

H. Lundbeck's Earnings Growth And 9.2% ROE

To start with, H. Lundbeck's ROE looks acceptable. Further, the company's ROE is similar to the industry average of 9.3%. For this reason, H. Lundbeck's five year net income decline of 22% raises the question as to why the decent ROE didn't translate into growth. We reckon that there could be some other factors at play here that are preventing 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.

So, as a next step, we compared H. Lundbeck's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 12% in the same period.

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). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about H. Lundbeck's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is H. Lundbeck Using Its Retained Earnings Effectively?

Looking at its three-year median payout ratio of 31% (or a retention ratio of 69%) which is pretty normal, H. Lundbeck's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Our latest analyst data shows that the future payout ratio of the company is expected to drop to 25% over the next three years. As a result, the expected drop in H. Lundbeck's payout ratio explains the anticipated rise in the company's future ROE to 16%, over the same period.

Summary

In total, it does look like H. Lundbeck has some positive aspects to its business. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.