Recordati Industria Chimica e Farmaceutica S.p.A.'s (BIT:REC) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

Recordati Industria Chimica e Farmaceutica (BIT:REC) has had a rough month with its share price down 5.8%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Recordati Industria Chimica e Farmaceutica's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Recordati Industria Chimica e Farmaceutica

How Is ROE Calculated?

ROE 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 Recordati Industria Chimica e Farmaceutica is:

30% = €389m ÷ €1.3b (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 €1 worth of equity, the company was able to earn €0.30 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Recordati Industria Chimica e Farmaceutica's Earnings Growth And 30% ROE

Firstly, we acknowledge that Recordati Industria Chimica e Farmaceutica has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 11% also doesn't go unnoticed by us. Probably as a result of this, Recordati Industria Chimica e Farmaceutica was able to see a decent net income growth of 14% over the last five years.

Next, on comparing with the industry net income growth, we found that Recordati Industria Chimica e Farmaceutica's growth is quite high when compared to the industry average growth of 11% in the same period, which is great to see.

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. If you're wondering about Recordati Industria Chimica e Farmaceutica's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Recordati Industria Chimica e Farmaceutica Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 59% (or a retention ratio of 41%) for Recordati Industria Chimica e Farmaceutica suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Moreover, Recordati Industria Chimica e Farmaceutica is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 50%. Accordingly, forecasts suggest that Recordati Industria Chimica e Farmaceutica's future ROE will be 26% which is again, similar to the current ROE.

Summary

In total, we are pretty happy with Recordati Industria Chimica e Farmaceutica's performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. 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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