UDG Healthcare (LON:UDG) has had a great run on the share market with its stock up by a significant 8.5% over the last month. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Particularly, we will be paying attention to UDG Healthcare's ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Is ROE Calculated?
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 UDG Healthcare is:
9.4% = US$93m ÷ US$984m (Based on the trailing twelve months to September 2020).
The 'return' is the income the business earned over the last year. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.09.
Why Is ROE Important For 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
A Side By Side comparison of UDG Healthcare's Earnings Growth And 9.4% ROE
To start with, UDG Healthcare's ROE looks acceptable. Further, the company's ROE is similar to the industry average of 9.4%. Despite the moderate return on equity, UDG Healthcare has posted a net income growth of 4.2% over the past five years. We reckon that a low growth, when returns are moderate could be the result of certain circumstances like low earnings retention or poor allocation of capital.
As a next step, we compared UDG Healthcare's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 8.3% in the same period.
Earnings growth is an important metric to consider when valuing a stock. 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. Is UDG fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is UDG Healthcare Using Its Retained Earnings Effectively?
With a high three-year median payout ratio of 73% (or a retention ratio of 27%), most of UDG Healthcare's profits are being paid to shareholders. This definitely contributes to the low earnings growth seen by the company.
Additionally, UDG Healthcare 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 33% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.
In total, it does look like UDG Healthcare has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.