Pharma Mar, S.A.'s (BME:PHM) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

It is hard to get excited after looking at Pharma Mar's (BME:PHM) recent performance, when its stock has declined 20% 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 Pharma Mar's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Pharma Mar

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 Pharma Mar is:

41% = €85m ÷ €207m (Based on the trailing twelve months to June 2022).

The 'return' is the yearly profit. So, this means that for every €1 of its shareholder's investments, the company generates a profit of €0.41.

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. 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.

Pharma Mar's Earnings Growth And 41% ROE

Firstly, we acknowledge that Pharma Mar has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 15% which is quite remarkable. Under the circumstances, Pharma Mar's considerable five year net income growth of 56% was to be expected.

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 21%.

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. Is Pharma Mar fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Pharma Mar Using Its Retained Earnings Effectively?

Pharma Mar's three-year median payout ratio to shareholders is 8.0%, which is quite low. This implies that the company is retaining 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.

Additionally, Pharma Mar has paid dividends over a period of three years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 7.9%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 42%.

Summary

Overall, we are quite pleased with Pharma Mar'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.