Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt.'s (BUSE:RICHTER) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

Most readers would already be aware that Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt's (BUSE:RICHTER) stock increased significantly by 13% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt

How Do You Calculate Return On Equity?

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 Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt is:

8.9% = Ft71b ÷ Ft796b (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every HUF1 worth of equity, the company was able to earn HUF0.09 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt's Earnings Growth And 8.9% ROE

At first glance, Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt's ROE doesn't look very promising. However, its ROE is similar to the industry average of 10%, so we won't completely dismiss the company. Having said that, Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt's net income growth over the past five years is more or less flat. Remember, the company's ROE is not particularly great to begin with. Hence, this provides some context to the flat earnings growth seen by the company.

As a next step, we compared Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt's net income growth with the industry and discovered that the industry saw an average growth of 11% 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is RICHTER worth today? The intrinsic value infographic in our free research report helps visualize whether RICHTER is currently mispriced by the market.

Is Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt Making Efficient Use Of Its Profits?

Despite having a moderate three-year median payout ratio of 43% (meaning the company retains57% of profits) in the last three-year period, Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt's earnings growth was more or les flat. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 24% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 15%, over the same period.

Conclusion

On the whole, we feel that the performance shown by Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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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