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Are strong financials driving the market?
Pro Medicus (ASX:PME) shares are up a considerable 21% in the last three months. Given that the market rewards strong financials over the long term, we wonder if that will be the case in this case. Specifically, we decided to study Pro Medicus’ ROE in this article.
Return on equity or ROE is an important factor for a shareholder to consider because it indicates how effectively their capital is being reinvested. Put another way, it reveals the company’s success in transforming shareholder investments into profits.
See our latest Pro Medicus review
How to calculate return on equity?
Return on equity can be calculated using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Equity
Therefore, based on the above formula, Pro Medicus’s ROE is:
44% = AU$70m ÷ AU$159m (Based on trailing twelve months to December 2023).
The ‘return’ is the annual profit. Another way to think of this is that for every A$1 in equity, the company was able to make A$0.44 in profit.
What does ROE have to do with earnings growth?
So 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 can then assess a company’s future ability to generate profits. Generally speaking, all other things being equal, companies with a high return on equity and profit retention have a higher growth rate than companies that do not share these attributes.
A side-by-side comparison of Pro Medicus’s earnings growth and 44% ROE
Firstly, we like that Pro Medicus has an impressive ROE. Furthermore, the company’s ROE is higher than the industry average of 11%, which is quite remarkable. So the substantial 29% net profit growth seen by Pro Medicus over the past five years isn’t too surprising.
Next, comparing this to the industry’s net profit growth, we find that Pro Medicus’ growth is quite high when compared to the industry average growth of 14% over the same period, which is great to see.
past profit growth
Earnings growth is an important metric to consider when valuing a stock. The investor should attempt to establish whether the expected growth or decline in earnings, whatever the case may be, is priced in. Doing so will give you an idea of whether the action is heading towards clear blue waters or if swampy waters await. If you are wondering about the Pro Medicus review, check out this indicator of your price/earnings ratiocompared to your industry.
Is Pro Medicus making efficient use of its profits?
Pro Medicus has a significant three-year average payout ratio of 51%, meaning the company only retains 49% of its revenue. This implies that the company managed to achieve high earnings growth despite returning most of its profits to shareholders.
The story continues
Furthermore, Pro Medicus is determined to continue sharing its profits with shareholders, which we deduce from its long history of paying dividends for at least ten years. Our latest analyst data shows that the company’s future payout ratio over the next three years is expected to be approximately 52%. As a result, Pro Medicus’s ROE is also not expected to change much, which we infer from the analysts’ estimate of 45% for future ROE.
Summary
All in all, we are very happy with the performance of Pro Medicus. We are particularly impressed by the considerable earnings growth recorded by the company, which was likely supported by its high ROE. Although the company is paying out most of its profits as dividends, it has nevertheless managed to grow its profits, which is probably a good sign. That said, the company’s earnings growth is expected to slow, as predicted by current analyst estimates. To learn 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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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your objectives or your financial situation. Our goal is to bring you long-term focused analysis driven by fundamental data. Please note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St has no position in any of the stocks mentioned.