H. Lundbeck A/S' (CPH:HLUN B) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

H. Lundbeck (CPH:HLUN B) has had a rough month with its share price down 5.8%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study H. Lundbeck's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out 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:

11% = kr.2.6b ÷ kr.23b (Based on the trailing twelve months to June 2024).

The 'return' is the profit 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 DKK0.11 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 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.

A Side By Side comparison of H. Lundbeck's Earnings Growth And 11% ROE

At first glance, H. Lundbeck seems to have a decent ROE. Even when compared to the industry average of 14% the company's ROE looks quite decent. Given the circumstances, we can't help but wonder why H. Lundbeck saw little to no growth in the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. These include low earnings retention or poor allocation of capital.

We then compared H. Lundbeck's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 13% in the same 5-year period, which is a bit concerning.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Making Efficient Use Of Its Profits?

Despite having a normal three-year median payout ratio of 27% (implying that the company keeps 73% of its income) over the last three years, H. Lundbeck has seen a negligible amount of growth in earnings as we saw above. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, H. Lundbeck only recently started paying a dividend so the management must have decided the shareholders prefer dividends over 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 22%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 13%.

Conclusion

On the whole, we do feel that H. Lundbeck has some positive attributes. 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. 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. 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.