Royalty Pharma plc (NASDAQ:RPRX) Stock's Been Sliding But Fundamentals Look Decent: Will The Market Correct The Share Price In The Future?

It is hard to get excited after looking at Royalty Pharma's (NASDAQ:RPRX) recent performance, when its stock has declined 8.3% over the past three months. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Royalty Pharma's 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.

Check out our latest analysis for Royalty Pharma

How Do You Calculate Return On Equity?

Return on equity 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 Royalty Pharma is:

12% = US$1.2b ÷ US$9.9b (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.12 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

Royalty Pharma's Earnings Growth And 12% ROE

To begin with, Royalty Pharma seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 14%. However, while Royalty Pharma has a pretty respectable ROE, its five year net income decline rate was 41% . So, there might be some other aspects that could explain this. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

As a next step, we compared Royalty Pharma's performance with the industry and found thatRoyalty Pharma's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 0.2% in the same period, which is a slower than the company.

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 Royalty Pharma fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Royalty Pharma Making Efficient Use Of Its Profits?

In spite of a normal three-year median payout ratio of 49% (that is, a retention ratio of 51%), the fact that Royalty Pharma's earnings have shrunk is quite puzzling. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

In addition, Royalty Pharma has been paying dividends over a period of four years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 20% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 24%, over the same period.

Conclusion

In total, it does look like Royalty Pharma has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.