Is Merck & Co., Inc.'s (NYSE:MRK) Recent Stock Performance Tethered To Its Strong Fundamentals?

Merck (NYSE:MRK) has had a great run on the share market with its stock up by a significant 5.7% over the last month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Merck'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Merck

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 Merck is:

11% = US$4.6b ÷ US$41b (Based on the trailing twelve months to September 2023).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.11 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 Merck's Earnings Growth And 11% ROE

At first glance, Merck seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 11%. This probably goes some way in explaining Merck's moderate 10% growth over the past five years amongst other factors.

We then performed a comparison between Merck's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 8.5% in the same 5-year period.

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. Is MRK fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Merck Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 64% (or a retention ratio of 36%) for Merck suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Besides, Merck has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 39% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 37%, over the same period.

Conclusion

In total, we are pretty happy with Merck's performance. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.