Novartis (VTX:NOVN) has had a great run on the share market with its stock up by a significant 5.6% over the last month. 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. In this article, we decided to focus on Novartis' ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.
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 Novartis is:
36% = US$22b ÷ US$61b (Based on the trailing twelve months to September 2022).
The 'return' is the profit over the last twelve months. So, this means that for every CHF1 of its shareholder's investments, the company generates a profit of CHF0.36.
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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Novartis' Earnings Growth And 36% ROE
First thing first, we like that Novartis has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 9.9% also doesn't go unnoticed by us. Probably as a result of this, Novartis was able to see a decent net income growth of 19% over the last five years.
Next, on comparing with the industry net income growth, we found that Novartis' growth is quite high when compared to the industry average growth of 11% in the same period, which is great to see.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. 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 Novartis is trading on a high P/E or a low P/E, relative to its industry.
Is Novartis Making Efficient Use Of Its Profits?
While Novartis has a three-year median payout ratio of 90% (which means it retains 9.7% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.
Moreover, Novartis is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 50% over the next three years. Still forecasts suggest that Novartis' future ROE will drop to 24% even though the the company's payout ratio is expected to decrease. This suggests that there could be other factors could driving the anticipated decline in the company's ROE.
On the whole, we do feel that Novartis has some positive attributes. Especially the growth in earnings which was backed by an impressive ROE. Still, the high ROE could have been even more beneficial to investors had the company been reinvesting more of its profits. As highlighted earlier, the current reinvestment rate appears to be negligible. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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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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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