MERCK Kommanditgesellschaft auf Aktien (ETR:MRK) has had a great run on the share market with its stock up by a significant 18% over the last month. 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. In this article, we decided to focus on MERCK Kommanditgesellschaft auf Aktien's 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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How To Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for MERCK Kommanditgesellschaft auf Aktien is:
7.2% = €1.3b ÷ €18b (Based on the trailing twelve months to December 2019).
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 €0.07 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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 MERCK Kommanditgesellschaft auf Aktien's Earnings Growth And 7.2% ROE
When you first look at it, MERCK Kommanditgesellschaft auf Aktien's ROE doesn't look that attractive. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 12%. As a result, MERCK Kommanditgesellschaft auf Aktien reported a very low income growth of 3.3% over the past five years.
We then compared MERCK Kommanditgesellschaft auf Aktien's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 12% in the same period, which is a bit concerning.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for MRK? You can find out in our latest intrinsic value infographic research report.
Is MERCK Kommanditgesellschaft auf Aktien Efficiently Re-investing Its Profits?
Despite having a moderate three-year median payout ratio of 34% (implying that the company retains the remaining 66% of its income), MERCK Kommanditgesellschaft auf Aktien's earnings growth was quite low. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
Additionally, MERCK Kommanditgesellschaft auf Aktien 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. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 20% over the next three years. The fact that the company's ROE is expected to rise to 12% over the same period is explained by the drop in the payout ratio.
Overall, we have mixed feelings about MERCK Kommanditgesellschaft auf Aktien. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. 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.
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