Could The Market Be Wrong About Novo Nordisk A/S (CPH:NOVO B) Given Its Attractive Financial Prospects?

With its stock down 5.5% over the past month, it is easy to disregard Novo Nordisk (CPH:NOVO B). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Novo Nordisk's ROE today.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Novo Nordisk

How Do You 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 Novo Nordisk is:

77% = kr.61b ÷ kr.80b (Based on the trailing twelve months to March 2023).

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 DKK0.77 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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Novo Nordisk's Earnings Growth And 77% ROE

First thing first, we like that Novo Nordisk has an impressive ROE. Secondly, even when compared to the industry average of 10% the company's ROE is quite impressive. This likely paved the way for the modest 8.7% net income growth seen by Novo Nordisk over the past five years.

As a next step, we compared Novo Nordisk's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 14% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for NOVO B? You can find out in our latest intrinsic value infographic research report.

Is Novo Nordisk Using Its Retained Earnings Effectively?

Novo Nordisk has a healthy combination of a moderate three-year median payout ratio of 49% (or a retention ratio of 51%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Besides, Novo Nordisk has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. 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 47%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 73%.

Conclusion

In total, we are pretty happy with Novo Nordisk's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a respectable growth in its earnings. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.