CVS Health Corporation (NYSE:CVS) Stock's Been Sliding But Fundamentals Look Decent: Will The Market Correct The Share Price In The Future?

With its stock down 15% over the past three months, it is easy to disregard CVS Health (NYSE:CVS). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on CVS Health'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for CVS Health

How Is ROE Calculated?

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:

5.8% = US$4.2b ÷ US$71b (Based on the trailing twelve months to December 2022).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.06 in profit.

What Is The Relationship Between ROE And 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

CVS Health's Earnings Growth And 5.8% 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 11%, the company's ROE leaves us feeling even less enthusiastic. Although, we can see that CVS Health saw a modest net income growth of 12% over the past five years. So, there might be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared CVS Health's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 15% in the same period, which is a bit concerning.

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. Doing so will help them establish if the stock's future looks promising or ominous. Is CVS Health fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is CVS Health Making Efficient Use Of Its Profits?

CVS Health has a three-year median payout ratio of 35%, which implies that it retains the remaining 65% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Moreover, CVS Health 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 28% over the next three years. As a result, the expected drop in CVS Health's payout ratio explains the anticipated rise in the company's future ROE to 15%, over the same period.

Conclusion

In total, it does look like CVS Health has some positive aspects to its business. Namely, its respectable earnings growth, which it achieved due to it retaining most of its profits. However, given the low ROE, investors may not be benefitting from all that reinvestment after all. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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.