CVS Health Corporation (NYSE:CVS) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?

Most readers would already be aware that CVS Health's (NYSE:CVS) stock increased significantly by 9.9% over the past month. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Particularly, we will be paying attention to CVS Health'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.

View our latest analysis for CVS Health

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for CVS Health is:

9.6% = US$7.2b ÷ US$75b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.10.

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. 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.

CVS Health's Earnings Growth And 9.6% ROE

On the face of it, CVS Health's ROE is not much to talk about. Next, when compared to the average industry ROE of 13%, the company's ROE leaves us feeling even less enthusiastic. Hence, the flat earnings seen by CVS Health over the past five years could probably be the result of it having a lower ROE.

Next, on comparing with the industry net income growth, we found that CVS Health's reported growth was lower than the industry growth of 6.2% over the last few years, which is not something we like to see.

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). This then helps them determine if the stock is placed for a bright or bleak future. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if CVS Health is trading on a high P/E or a low P/E, relative to its industry.

Is CVS Health Making Efficient Use Of Its Profits?

In spite of a normal three-year median payout ratio of 37% (or a retention ratio of 63%), CVS Health hasn't seen much growth in its earnings. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, CVS Health 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 32%. Still, forecasts suggest that CVS Health's future ROE will rise to 12% even though the the company's payout ratio is not expected to change by much.

Summary

Overall, we have mixed feelings about CVS Health. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.