Novolog (Pharm-Up 1966) Ltd's (TLV:NVLG) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

Novolog (Pharm-Up 1966)'s (TLV:NVLG) stock is up by a considerable 9.9% over the past month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Novolog (Pharm-Up 1966)'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Novolog (Pharm-Up 1966)

How Is ROE Calculated?

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 Novolog (Pharm-Up 1966) is:

13% = ₪38m ÷ ₪286m (Based on the trailing twelve months to September 2020).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each ₪1 of shareholders' capital it has, the company made ₪0.13 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. 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.

A Side By Side comparison of Novolog (Pharm-Up 1966)'s Earnings Growth And 13% ROE

To begin with, Novolog (Pharm-Up 1966) seems to have a respectable ROE. On comparing with the average industry ROE of 9.1% the company's ROE looks pretty remarkable. As you might expect, the 5.8% net income decline reported by Novolog (Pharm-Up 1966) is a bit of a surprise. We reckon that there could be some other factors at play here that are preventing the company's growth. These include low earnings retention or poor allocation of capital.

So, as a next step, we compared Novolog (Pharm-Up 1966)'s performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 7.3% in the same 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. 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 Novolog (Pharm-Up 1966) is trading on a high P/E or a low P/E, relative to its industry.

Is Novolog (Pharm-Up 1966) Making Efficient Use Of Its Profits?

Looking at its three-year median payout ratio of 47% (or a retention ratio of 53%) which is pretty normal, Novolog (Pharm-Up 1966)'s declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Moreover, Novolog (Pharm-Up 1966) has been paying dividends for four years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking.

Summary

On the whole, we do feel that Novolog (Pharm-Up 1966) has some positive attributes. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard would have the 2 risks we have identified for Novolog (Pharm-Up 1966).

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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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