H. Lundbeck A/S' (CPH:HLUN B) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

With its stock down 5.6% over the past three months, it is easy to disregard H. Lundbeck (CPH:HLUN B). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study H. Lundbeck'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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for H. Lundbeck

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for H. Lundbeck is:

10% = kr.2.3b ÷ kr.22b (Based on the trailing twelve months to December 2023).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every DKK1 worth of equity, the company was able to earn DKK0.10 in profit.

What Has ROE Got To Do With 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.

A Side By Side comparison of H. Lundbeck's Earnings Growth And 10% ROE

To begin with, H. Lundbeck seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 11%. As you might expect, the 10% net income decline reported by H. Lundbeck is a bit of a surprise. So, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.

However, when we compared H. Lundbeck's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 10% in the same period. This is quite worrisome.

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

Is H. Lundbeck Efficiently Re-investing Its Profits?

Looking at its three-year median payout ratio of 27% (or a retention ratio of 73%) 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. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Only recently, H. Lundbeck stated paying a dividend. This likely means that the management might have concluded that its shareholders have a strong preference for dividends. 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 23%. However, H. Lundbeck's ROE is predicted to rise to 15% despite there being no anticipated change in its payout ratio.

Conclusion

On the whole, we do feel that H. Lundbeck has some positive attributes. 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. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.