Most readers would already be aware that Photocure's (OB:PHO) stock increased significantly by 20% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to Photocure's ROE today.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
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 Photocure is:
2.0% = kr9.9m ÷ kr492m (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 NOK1 of shareholders' capital it has, the company made NOK0.02 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. 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. 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.
Photocure's Earnings Growth And 2.0% ROE
It is hard to argue that Photocure's ROE is much good in and of itself. Not just that, even compared to the industry average of 10%, the company's ROE is entirely unremarkable. However, the moderate 15% net income growth seen by Photocure over the past five years is definitely a positive. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place.
As a next step, we compared Photocure's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 11%.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Photocure fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Photocure Efficiently Re-investing Its Profits?
Photocure doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the decent earnings growth number that we discussed above.
In total, it does look like Photocure has some positive aspects to its business. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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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