Vanda Pharmaceuticals (NASDAQ:VNDA) has had a great run on the share market with its stock up by a significant 16% over the last three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Particularly, we will be paying attention to Vanda Pharmaceuticals' 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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Do You 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 Vanda Pharmaceuticals is:
5.1% = US$23m ÷ US$453m (Based on the trailing twelve months to December 2020).
The 'return' is the profit over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.05.
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.
A Side By Side comparison of Vanda Pharmaceuticals' Earnings Growth And 5.1% ROE
At first glance, Vanda Pharmaceuticals' ROE doesn't look very promising. Next, when compared to the average industry ROE of 21%, the company's ROE leaves us feeling even less enthusiastic. Despite this, surprisingly, Vanda Pharmaceuticals saw an exceptional 70% net income growth over the past five years. We reckon that there could be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
As a next step, we compared Vanda Pharmaceuticals' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 13%.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Vanda Pharmaceuticals''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Vanda Pharmaceuticals Using Its Retained Earnings Effectively?
On the whole, we do feel that Vanda Pharmaceuticals has some positive attributes. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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. 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.
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