Does Laboratorio Reig Jofre, S.A.'s (BME:RJF) Weak Fundamentals Mean That The Market Could Correct Its Share Price?

Most readers would already be aware that Laboratorio Reig Jofre's (BME:RJF) stock increased significantly by 12% over the past week. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. Particularly, we will be paying attention to Laboratorio Reig Jofre's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Laboratorio Reig Jofre

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 Laboratorio Reig Jofre is:

5.8% = €12m ÷ €202m (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. That means that for every €1 worth of shareholders' equity, the company generated €0.06 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.

Laboratorio Reig Jofre's Earnings Growth And 5.8% ROE

On the face of it, Laboratorio Reig Jofre's ROE is not much to talk about. Next, when compared to the average industry ROE of 12%, the company's ROE leaves us feeling even less enthusiastic. Hence, the flat earnings seen by Laboratorio Reig Jofre over the past five years could probably be the result of it having a lower ROE.

Next, on comparing with the industry net income growth, we found that the industry grew its earnings by 13% over the last few years.

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. This then helps them determine if the stock is placed for a bright or bleak future. 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 Laboratorio Reig Jofre is trading on a high P/E or a low P/E, relative to its industry.

Is Laboratorio Reig Jofre Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 61% (implying that the company keeps only 39% of its income) of its business to reinvest into its business), most of Laboratorio Reig Jofre's profits are being paid to shareholders, which explains the absence of growth in earnings.

In addition, Laboratorio Reig Jofre only recently started paying a dividend so the management must have decided the shareholders prefer dividends over earnings growth.

Summary

On the whole, Laboratorio Reig Jofre's performance is quite a big let-down. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.