Are Strong Financial Prospects The Force That Is Driving The Momentum In Hikma Pharmaceuticals PLC's LON:HIK) Stock?

Hikma Pharmaceuticals' (LON:HIK) stock is up by a considerable 10% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Particularly, we will be paying attention to Hikma Pharmaceuticals' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Hikma Pharmaceuticals

How To 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 Hikma Pharmaceuticals is:

27% = US$514m ÷ US$1.9b (Based on the trailing twelve months to June 2020).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.27 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

A Side By Side comparison of Hikma Pharmaceuticals' Earnings Growth And 27% ROE

First thing first, we like that Hikma Pharmaceuticals has an impressive ROE. Secondly, even when compared to the industry average of 16% the company's ROE is quite impressive. This probably laid the groundwork for Hikma Pharmaceuticals' moderate 9.9% net income growth seen over the past five years.

Next, on comparing Hikma Pharmaceuticals' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 9.9% in the same period.

past-earnings-growth

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 Hikma Pharmaceuticals is trading on a high P/E or a low P/E, relative to its industry.

Is Hikma Pharmaceuticals Efficiently Re-investing Its Profits?

Hikma Pharmaceuticals' three-year median payout ratio to shareholders is 22% (implying that it retains 78% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Moreover, Hikma Pharmaceuticals 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. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 27% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 16% over the same period.

Summary

In total, we are pretty happy with Hikma Pharmaceuticals' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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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