Novo Nordisk A/S' (CPH:NOVO B) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

It is hard to get excited after looking at Novo Nordisk's (CPH:NOVO B) recent performance, when its stock has declined 17% over the past three months. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Novo Nordisk

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 Novo Nordisk is:

80% = kr.90b ÷ kr.113b (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. That means that for every DKK1 worth of shareholders' equity, the company generated DKK0.80 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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Novo Nordisk's Earnings Growth And 80% ROE

To begin with, Novo Nordisk has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 12% which is quite remarkable. This probably laid the groundwork for Novo Nordisk's moderate 19% net income growth seen over the past five years.

As a next step, we compared Novo Nordisk's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 9.3%.

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. Is NOVO B fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Novo Nordisk Using Its Retained Earnings Effectively?

Novo Nordisk has a three-year median payout ratio of 48%, which implies that it retains the remaining 52% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Moreover, Novo Nordisk is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 51% of its profits over the next three years. As a result, Novo Nordisk's ROE is not expected to change by much either, which we inferred from the analyst estimate of 65% for future ROE.

Conclusion

Overall, we are quite pleased with Novo Nordisk's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.