Pro Medicus' (ASX:PME) stock is up by a considerable 30% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to Pro Medicus' ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Pro Medicus is:
40% = AU$38m ÷ AU$95m (Based on the trailing twelve months to June 2022).
The 'return' is the income the business earned over the last year. That means that for every A$1 worth of shareholders' equity, the company generated A$0.40 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. 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 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.
Pro Medicus' Earnings Growth And 40% ROE
Firstly, we acknowledge that Pro Medicus has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 12% which is quite remarkable. Under the circumstances, Pro Medicus' considerable five year net income growth of 31% was to be expected.
We then compared Pro Medicus' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 41% in the same period, which is a bit concerning.
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). This then helps them determine if the stock is placed for a bright or bleak future. Is Pro Medicus fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Pro Medicus Making Efficient Use Of Its Profits?
Pro Medicus has a significant three-year median payout ratio of 51%, meaning the company only retains 49% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.
Besides, Pro Medicus 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 over the next three years is expected to be approximately 47%. As a result, Pro Medicus' ROE is not expected to change by much either, which we inferred from the analyst estimate of 40% for future ROE.
On the whole, we do feel that Pro Medicus has some positive attributes. Its earnings have grown respectably as we saw earlier, which was likely due to the company reinvesting its earnings at a pretty high rate of return. However, given the high ROE, we do think that the company is reinvesting a small portion of its profits. This could likely be preventing the company from growing to its full extent. 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 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.
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