Are Strong Financial Prospects The Force That Is Driving The Momentum In Pharmanutra S.p.A.'s BIT:PHN) Stock?

Pharmanutra (BIT:PHN) has had a great run on the share market with its stock up by a significant 12% over the last three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Pharmanutra's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Pharmanutra

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 Pharmanutra is:

40% = €14m ÷ €35m (Based on the trailing twelve months to September 2020).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every €1 worth of equity, the company was able to earn €0.40 in profit.

What Is The Relationship Between ROE And Earnings Growth?

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

Pharmanutra's Earnings Growth And 40% ROE

First thing first, we like that Pharmanutra has an impressive ROE. Secondly, even when compared to the industry average of 12% the company's ROE is quite impressive. So, the substantial 30% net income growth seen by Pharmanutra over the past five years isn't overly surprising.

We then compared Pharmanutra's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 60% in the same period, which is a bit concerning.

Earnings growth is a huge factor in stock valuation. 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. If you're wondering about Pharmanutra's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Pharmanutra Using Its Retained Earnings Effectively?

Pharmanutra has a three-year median payout ratio of 46% (where it is retaining 54% of its income) which is not too low or not too high. By the looks of it, the dividend is well covered and Pharmanutra is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Besides, Pharmanutra has been paying dividends over a period of three years. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 43% of its profits over the next three years. Still, forecasts suggest that Pharmanutra's future ROE will drop to 26% even though the the company's payout ratio is not expected to change by much.

Conclusion

In total, we are pretty happy with Pharmanutra's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a respectable growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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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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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