Should Weakness in Zimmer Biomet Holdings, Inc.'s (NYSE:ZBH) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

With its stock down 11% over the past three months, it is easy to disregard Zimmer Biomet Holdings (NYSE:ZBH). 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. Specifically, we decided to study Zimmer Biomet Holdings' ROE in this article.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Zimmer Biomet Holdings

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 Zimmer Biomet Holdings is:

7.8% = US$998m ÷ US$13b (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.08.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

A Side By Side comparison of Zimmer Biomet Holdings' Earnings Growth And 7.8% ROE

On the face of it, Zimmer Biomet Holdings' ROE is not much to talk about. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 11%. In spite of this, Zimmer Biomet Holdings was able to grow its net income considerably, at a rate of 28% in the last five years. Therefore, there could be other reasons behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that Zimmer Biomet Holdings' growth is quite high when compared to the industry average growth of 11% in the same period, which is great to see.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Zimmer Biomet Holdings is trading on a high P/E or a low P/E, relative to its industry.

Is Zimmer Biomet Holdings Efficiently Re-investing Its Profits?

The three-year median payout ratio for Zimmer Biomet Holdings is 42%, which is moderately low. The company is retaining the remaining 58%. By the looks of it, the dividend is well covered and Zimmer Biomet Holdings is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Moreover, Zimmer Biomet Holdings 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 10% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 14%, over the same period.

Summary

Overall, we feel that Zimmer Biomet Holdings certainly does have some positive factors to consider. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.

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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.