It is hard to get excited after looking at Procter & Gamble Health's (NSE:PGHL) recent performance, when its stock has declined 7.2% over the past month. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Procter & Gamble Health's ROE today.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company's success at turning shareholder investments into profits.
How To 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 Procter & Gamble Health is:
34% = ₹2.2b ÷ ₹6.4b (Based on the trailing twelve months to December 2020).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.34 in profit.
Why Is ROE Important For 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
A Side By Side comparison of Procter & Gamble Health's Earnings Growth And 34% ROE
First thing first, we like that Procter & Gamble Health has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 14% also doesn't go unnoticed by us. As a result, Procter & Gamble Health's exceptional 26% net income growth seen over the past five years, doesn't come as a surprise.
Next, on comparing with the industry net income growth, we found that Procter & Gamble Health's growth is quite high when compared to the industry average growth of 16% in the same period, which is great to see.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Procter & Gamble Health is trading on a high P/E or a low P/E, relative to its industry.
Is Procter & Gamble Health Efficiently Re-investing Its Profits?
The three-year median payout ratio for Procter & Gamble Health is 34%, which is moderately low. The company is retaining the remaining 66%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Procter & Gamble Health is reinvesting its earnings efficiently.
Additionally, Procter & Gamble Health 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.
Overall, we are quite pleased with Procter & Gamble Health's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. You can see the 1 risk we have identified for Procter & Gamble Health by visiting our risks dashboard for free on our platform here.
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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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