Declining Stock and Decent Financials: Is The Market Wrong About Zentiva S.A. (BVB:SCD)?

With its stock down 14% over the past three months, it is easy to disregard Zentiva (BVB:SCD). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Zentiva's ROE.

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.

See our latest analysis for Zentiva

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 Zentiva is:

11% = RON95m ÷ RON880m (Based on the trailing twelve months to December 2021).

The 'return' refers to a company's earnings over the last year. That means that for every RON1 worth of shareholders' equity, the company generated RON0.11 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. 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.

A Side By Side comparison of Zentiva's Earnings Growth And 11% ROE

At first glance, Zentiva seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 13%. However, while Zentiva has a pretty respectable ROE, its five year net income decline rate was 10% . We reckon that there could be some other factors at play here that are preventing the company's growth. These include low earnings retention or poor allocation of capital.

However, when we compared Zentiva's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 12% in the same period. This is quite worrisome.

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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Zentiva's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Zentiva Efficiently Re-investing Its Profits?

Because Zentiva doesn't pay any dividends, we infer that it is retaining all of its profits, which is rather perplexing when you consider the fact that there is no earnings growth to show for it. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Summary

On the whole, we do feel that Zentiva has some positive attributes. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 1 risk we have identified for Zentiva visit our risks dashboard for free.

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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.