It is hard to get excited after looking at Pharma Mar's (BME:PHM) recent performance, when its stock has declined 34% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Pharma Mar'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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Do You Calculate Return On Equity?
ROE can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Pharma Mar is:
43% = €61m ÷ €143m (Based on the trailing twelve months to September 2021).
The 'return' is the amount earned after tax over the last twelve months. That means that for every €1 worth of shareholders' equity, the company generated €0.43 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. 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. 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.
Pharma Mar's Earnings Growth And 43% ROE
To begin with, Pharma Mar has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 13% which is quite remarkable. So, the substantial 62% net income growth seen by Pharma Mar over the past five years isn't overly surprising.
As a next step, we compared Pharma Mar'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 22%.
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). 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 Pharma Mar is trading on a high P/E or a low P/E, relative to its industry.
Is Pharma Mar Making Efficient Use Of Its Profits?
Pharma Mar's ' LTM (or last twelve month) payout ratio is on the lower side at 8.0% implying that it is retaining a higher percentage (92%) of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.
While Pharma Mar has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 8.2%. As a result, Pharma Mar's ROE is not expected to change by much either, which we inferred from the analyst estimate of 38% for future ROE.
In total, we are pretty happy with Pharma Mar'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 sizeable 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.