Yahoo Finance Merck & Co., Inc.'s (NYSE:MRK) Stock Financial Prospects Look Bleak: Should Shareholders Be Prepared For A Share Price Correction?
Merck's (NYSE:MRK) stock is up by 2.7% over the past week. Given that the markets usually pay for the long-term financial health of a company, we wonder if the current momentum in the share price will keep up, given that the company's financials don't look very promising. In this article, we decided to focus on Merck's ROE.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company's success at turning shareholder investments into profits.
See our latest analysis for Merck
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 Merck is:
5.7% = US$2.3b ÷ US$40b (Based on the trailing twelve months to March 2024).
The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.06 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. 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.
Merck's Earnings Growth And 5.7% ROE
On the face of it, Merck's ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 15% either. For this reason, Merck's five year net income decline of 3.8% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.
So, as a next step, we compared Merck's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 0.03% over the last few years.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Is Merck fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Merck Efficiently Re-investing Its Profits?
With a three-year median payout ratio as high as 110%,Merck's shrinking earnings don't come as a surprise as the company is paying a dividend which is beyond its means. Its usually very hard to sustain dividend payments that are higher than reported profits. Our risks dashboard should have the 4 risks we have identified for Merck.
In addition, Merck has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 32% over the next three years. The fact that the company's ROE is expected to rise to 39% over the same period is explained by the drop in the payout ratio.
Conclusion
Overall, we would be extremely cautious before making any decision on Merck. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com
