Declining Stock and Decent Financials: Is The Market Wrong About Hikma Pharmaceuticals PLC (LON:HIK)?

Hikma Pharmaceuticals (LON:HIK) has had a rough three months with its share price down 9.7%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Hikma Pharmaceuticals' ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

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How To 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 Hikma Pharmaceuticals is:

16% = US$362m ÷ US$2.3b (Based on the trailing twelve months to December 2024).

The 'return' refers to a company's earnings over the last year. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.16.

See our latest analysis for Hikma Pharmaceuticals

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

Hikma Pharmaceuticals' Earnings Growth And 16% ROE

To start with, Hikma Pharmaceuticals' ROE looks acceptable. On comparing with the average industry ROE of 12% the company's ROE looks pretty remarkable. Needless to say, we are quite surprised to see that Hikma Pharmaceuticals' net income shrunk at a rate of 18% over the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

That being said, we compared Hikma Pharmaceuticals' performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 7.7% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is HIK fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Hikma Pharmaceuticals Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 61% (implying that 39% of the profits are retained), most of Hikma Pharmaceuticals' profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent.

In addition, Hikma Pharmaceuticals has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 36% over the next three years. The fact that the company's ROE is expected to rise to 19% over the same period is explained by the drop in the payout ratio.

Conclusion

On the whole, we do feel that Hikma Pharmaceuticals has some positive attributes. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.