Most readers would already know that Thermo Fisher Scientific's (NYSE:TMO) stock increased by 5.8% over the past three months. Given its impressive performance, we decided to study the company's key financial indicators as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Thermo Fisher Scientific's 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Do You 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 Thermo Fisher Scientific is:
15% = US$4.9b ÷ US$32b (Based on the trailing twelve months to September 2020).
The 'return' is the yearly profit. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.15 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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.
Thermo Fisher Scientific's Earnings Growth And 15% ROE
To start with, Thermo Fisher Scientific's ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 15%. This certainly adds some context to Thermo Fisher Scientific's moderate 18% net income growth seen over the past five years.
We then compared Thermo Fisher Scientific's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 13% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Thermo Fisher Scientific is trading on a high P/E or a low P/E, relative to its industry.
Is Thermo Fisher Scientific Making Efficient Use Of Its Profits?
Thermo Fisher Scientific has a low three-year median payout ratio of 8.9%, meaning that the company retains the remaining 91% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.
Additionally, Thermo Fisher Scientific has paid dividends over a period of nine years which means that the company is pretty serious about sharing its profits with shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 5.2% over the next three years. The fact that the company's ROE is expected to rise to 21% over the same period is explained by the drop in the payout ratio.
Overall, we are quite pleased with Thermo Fisher Scientific's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. 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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