Fisher & Paykel Healthcare Corporation Limited's (NZSE:FPH) Stock Going Strong But Fundamentals Look Weak: What Implications Could This Have On The Stock?

Fisher & Paykel Healthcare (NZSE:FPH) has had a great run on the share market with its stock up by a significant 25% over the last three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. In this article, we decided to focus on Fisher & Paykel Healthcare's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Fisher & Paykel Healthcare

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 Fisher & Paykel Healthcare is:

7.5% = NZ$133m ÷ NZ$1.8b (Based on the trailing twelve months to March 2024).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every NZ$1 worth of equity, the company was able to earn NZ$0.08 in profit.

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. 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.

A Side By Side comparison of Fisher & Paykel Healthcare's Earnings Growth And 7.5% ROE

When you first look at it, Fisher & Paykel Healthcare's ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 7.4%, we may spare it some thought. But then again, Fisher & Paykel Healthcare's five year net income shrunk at a rate of 4.6%. Remember, the company's ROE is a bit low to begin with. Hence, this goes some way in explaining the shrinking earnings.

So, as a next step, we compared Fisher & Paykel Healthcare's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 7.5% over the last few years.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 Using Its Retained Earnings Effectively?

Fisher & Paykel Healthcare has a high three-year median payout ratio of 91% (that is, it is retaining 9.2% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. 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.

Additionally, Fisher & Paykel Healthcare has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 65% over the next three years. The fact that the company's ROE is expected to rise to 24% over the same period is explained by the drop in the payout ratio.

Conclusion

On the whole, Fisher & Paykel Healthcare's performance is quite a big let-down. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.