Are Strong Financial Prospects The Force That Is Driving The Momentum In Laboratorios Farmaceuticos Rovi, S.A.'s BME:ROVI) Stock?

Most readers would already be aware that Laboratorios Farmaceuticos Rovi's (BME:ROVI) stock increased significantly by 32% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Laboratorios Farmaceuticos Rovi'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Laboratorios Farmaceuticos Rovi

How Is ROE Calculated?

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 Laboratorios Farmaceuticos Rovi is:

15% = €55m ÷ €369m (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. That means that for every €1 worth of shareholders' equity, the company generated €0.15 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

Laboratorios Farmaceuticos Rovi's Earnings Growth And 15% ROE

To start with, Laboratorios Farmaceuticos Rovi's ROE looks acceptable. Especially when compared to the industry average of 11% the company's ROE looks pretty impressive. This certainly adds some context to Laboratorios Farmaceuticos Rovi's decent 18% net income growth seen over the past five years.

As a next step, we compared Laboratorios Farmaceuticos Rovi'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 11%.

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. If you're wondering about Laboratorios Farmaceuticos Rovi's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Laboratorios Farmaceuticos Rovi Using Its Retained Earnings Effectively?

Laboratorios Farmaceuticos Rovi has a low three-year median payout ratio of 24%, meaning that the company retains the remaining 76% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Besides, Laboratorios Farmaceuticos Rovi has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 28%. However, Laboratorios Farmaceuticos Rovi's ROE is predicted to rise to 20% despite there being no anticipated change in its payout ratio.

Summary

Overall, we are quite pleased with Laboratorios Farmaceuticos Rovi's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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. 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.
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