Alliance Pharma plc's (LON:APH) Financials Are Too Obscure To Link With Current Share Price Momentum: What's In Store For the Stock?

Most readers would already be aware that Alliance Pharma's (LON:APH) stock increased significantly by 11% over the past week. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. Specifically, we decided to study Alliance Pharma's ROE in this article.

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.

See our latest analysis for Alliance Pharma

How Do You Calculate Return On Equity?

Return on equity 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 Alliance Pharma is:

2.9% = UK£8.0m ÷ UK£281m (Based on the trailing twelve months to December 2020).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.03 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

A Side By Side comparison of Alliance Pharma's Earnings Growth And 2.9% ROE

As you can see, Alliance Pharma's ROE looks pretty weak. Even when compared to the industry average of 16%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 3.8% seen by Alliance Pharma over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.

So, as a next step, we compared Alliance Pharma'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 15% in the same period.

past-earnings-growth

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

Is Alliance Pharma Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 27% (that is, a retention ratio of 73%), the fact that Alliance Pharma's earnings have shrunk is quite puzzling. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, Alliance Pharma has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 26%. Regardless, the future ROE for Alliance Pharma is predicted to rise to 11% despite there being not much change expected in its payout ratio.

Conclusion

Overall, we have mixed feelings about Alliance Pharma. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

This article by Simply Wall St is general in nature. 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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