Can Fisher & Paykel Healthcare Corporation Limited's (NZSE:FPH) Weak Financials Pull The Plug On The Stock's Current Momentum On Its Share Price?

Fisher & Paykel Healthcare's (NZSE:FPH) stock is up by a considerable 11% over the past month. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. In this article, we decided to focus on Fisher & Paykel Healthcare's ROE.

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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Our free stock report includes 2 warning signs investors should be aware of before investing in Fisher & Paykel Healthcare. Read for free now.

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 Fisher & Paykel Healthcare is:

9.2% = NZ$179m ÷ NZ$1.9b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each NZ$1 of shareholders' capital it has, the company made NZ$0.09 in profit.

View our latest analysis for Fisher & Paykel Healthcare

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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.

Fisher & Paykel Healthcare's Earnings Growth And 9.2% ROE

At first glance, Fisher & Paykel Healthcare's ROE doesn't look very promising. However, its ROE is similar to the industry average of 9.2%, so we won't completely dismiss the company. But then again, Fisher & Paykel Healthcare's five year net income shrunk at a rate of 13%. Remember, the company's ROE is a bit low to begin with. Therefore, the decline in earnings could also be the result of this.

However, when we compared Fisher & Paykel Healthcare's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 14% in the same period. This is quite worrisome.

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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Fisher & Paykel Healthcare's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Fisher & Paykel Healthcare Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 92% (implying that 7.8% of the profits are retained), most of Fisher & Paykel Healthcare's profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 2 risks we have identified for Fisher & Paykel Healthcare by visiting our risks dashboard for free on our platform here.

In addition, Fisher & Paykel Healthcare has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 66% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 24%, over the same period.

Summary

Overall, we would be extremely cautious before making any decision on Fisher & Paykel Healthcare. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.