Are Robust Financials Driving The Recent Rally In Vita Life Sciences Limited's (ASX:VLS) Stock?

editorial-team@simplywallst.com (Simply Wall St)

Sun, Oct 8, 2023, 11:29 PM 4 min read

Vita Life Sciences (ASX:VLS) has had a great run on the share market with its stock up by a significant 9.0% over the last month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Vita Life Sciences' 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Vita Life Sciences

How Do You Calculate Return On Equity?

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 Vita Life Sciences is:

20% = AU$7.7m ÷ AU$39m (Based on the trailing twelve months to June 2023).

The 'return' is the amount earned after tax over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.20 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. 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. 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.

Vita Life Sciences' Earnings Growth And 20% ROE

At first glance, Vita Life Sciences seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 20%. This probably goes some way in explaining Vita Life Sciences' significant 24% net income growth over the past five years amongst other factors. We believe that there might also 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.

We then compared Vita Life Sciences' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 31% in the same 5-year period, which is a bit concerning.

past-earnings-growth — ASX:VLS Past Earnings Growth October 9th 2023

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Vita Life Sciences is trading on a high P/E or a low P/E, relative to its industry.

Is Vita Life Sciences Using Its Retained Earnings Effectively?

Vita Life Sciences has a three-year median payout ratio of 40% (where it is retaining 60% of its income) which is not too low or not too high. So it seems that Vita Life Sciences is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Additionally, Vita Life Sciences 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.

Summary

Overall, we are quite pleased with Vita Life Sciences' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. To know the 2 risks we have identified for Vita Life Sciences visit our risks dashboard for free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using 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 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.