Is Weakness In Vetoquinol SA (EPA:VETO) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

With its stock down 7.6% over the past three months, it is easy to disregard Vetoquinol (EPA:VETO). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Vetoquinol's ROE in this article.

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 Vetoquinol

How To Calculate Return On Equity?

Return on equity 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 Vetoquinol is:

14% = €63m ÷ €441m (Based on the trailing twelve months to December 2021).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each €1 of shareholders' capital it has, the company made €0.14 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. 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.

Vetoquinol's Earnings Growth And 14% ROE

To begin with, Vetoquinol seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 14%. This certainly adds some context to Vetoquinol's moderate 6.6% net income growth seen over the past five years.

As a next step, we compared Vetoquinol's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 17% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is VETO fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Vetoquinol Using Its Retained Earnings Effectively?

Vetoquinol has a low three-year median payout ratio of 16%, meaning that the company retains the remaining 84% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Additionally, Vetoquinol has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 10% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.

Conclusion

In total, we are pretty happy with Vetoquinol's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.