Abbott Laboratories (NYSE:ABT) has had a great run on the share market with its stock up by a significant 7.5% over the last month. 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. Specifically, we decided to study Abbott Laboratories’ ROE in this article.
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. In simpler terms, it measures the profitability of a company in relation to shareholder’s equity.
How To Calculate Return On Equity?
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 Abbott Laboratories is:
10% = US$3.1b ÷ US$31b (Based on the trailing twelve months to June 2020).
The ‘return’ is the income the business earned over the last year. One way to conceptualize this is that for each $1 of shareholders’ capital it has, the company made $0.10 in profit.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company’s future earnings. Based on how much of its profits the company chooses to reinvest or “retain”, we are then able to evaluate a company’s future ability to generate profits. 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.
Abbott Laboratories’ Earnings Growth And 10% ROE
On the face of it, Abbott Laboratories’ ROE is not much to talk about. However, its ROE is similar to the industry average of 11%, so we won’t completely dismiss the company. Having said that, Abbott Laboratories has shown a modest net income growth of 12% over the past five years. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company’s growth. For instance, the company has a low payout ratio or is being managed efficiently.
As a next step, we compared Abbott Laboratories’ net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 14% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company’s expected earnings growth (or decline). Doing so will help them establish if the stock’s future looks promising or ominous. If you’re wondering about Abbott Laboratories”s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Abbott Laboratories Using Its Retained Earnings Effectively?
The high three-year median payout ratio of 88% (or a retention ratio of 12%) for Abbott Laboratories suggests that the company’s growth wasn’t really hampered despite it returning most of its income to its shareholders.
Moreover, Abbott Laboratories 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. Upon studying the latest analysts’ consensus data, we found that the company’s future payout ratio is expected to drop to 36% over the next three years. As a result, the expected drop in Abbott Laboratories’ payout ratio explains the anticipated rise in the company’s future ROE to 18%, over the same period.
On the whole, we do feel that Abbott Laboratories has some positive attributes. That is, quite an impressive growth in earnings. However, the low profit retention means that the company’s earnings growth could have been higher, had it been reinvesting a higher portion of its profits. Having said that, looking at the current analyst estimates, we found that the company’s earnings are expected to gain momentum. 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.
If you decide to trade Abbott Laboratories, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account.
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email email@example.com.