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Most readers would already be aware that Dechra Pharmaceuticals' (LON:DPH) stock increased significantly by 24% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on Dechra Pharmaceuticals' ROE.
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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
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 Dechra Pharmaceuticals is:
7.0% = UK£44m ÷ UK£625m (Based on the trailing twelve months to December 2020).
The 'return' is the yearly profit. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.07 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. 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 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.
Dechra Pharmaceuticals' Earnings Growth And 7.0% ROE
On the face of it, Dechra Pharmaceuticals' ROE is not much to talk about. Next, when compared to the average industry ROE of 20%, the company's ROE leaves us feeling even less enthusiastic. Dechra Pharmaceuticals was still able to see a decent net income growth of 16% over the past five years. So, there might be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.
As a next step, we compared Dechra Pharmaceuticals' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 14% in the same period.
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). This then helps them determine if the stock is placed for a bright or bleak future. Is Dechra Pharmaceuticals fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Dechra Pharmaceuticals Making Efficient Use Of Its Profits?
The really high three-year median payout ratio of 104% for Dechra Pharmaceuticals suggests that the company is paying its shareholders more than what it is earning. However, this hasn't really hampered its ability to grow as we saw earlier. It would still be worth keeping an eye on that high payout ratio, if for some reason the company runs into problems and business deteriorates. You can see the 3 risks we have identified for Dechra Pharmaceuticals by visiting our risks dashboard for free on our platform here.
Additionally, Dechra Pharmaceuticals has paid dividends over a period of at least ten 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 35% over the next three years. The fact that the company's ROE is expected to rise to 18% over the same period is explained by the drop in the payout ratio.
On the whole, we feel that the performance shown by Dechra Pharmaceuticals can be open to many interpretations. Although the company has shown a pretty impressive growth in earnings, yet the low ROE and the low rate of reinvestment makes us skeptical about the continuity of that growth, especially when or if the business comes to face any threats. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.
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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