With its stock down 2.2% over the past week, it is easy to disregard Australian Pharmaceutical Industries (ASX:API). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Australian Pharmaceutical Industries' ROE in this article.
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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
View our latest analysis for Australian Pharmaceutical Industries
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 Australian Pharmaceutical Industries is:
11% = AU$54m ÷ AU$509m (Based on the trailing twelve months to February 2020).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.11.
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 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.
Australian Pharmaceutical Industries' Earnings Growth And 11% ROE
To start with, Australian Pharmaceutical Industries' ROE looks acceptable. Even when compared to the industry average of 11% the company's ROE looks quite decent. Despite the moderate return on equity, Australian Pharmaceutical Industries has posted a net income growth of 2.7% over the past five years. A few likely reasons that could be keeping earnings growth low are - the company has a high payout ratio or the business has allocated capital poorly, for instance.
We then performed a comparison between Australian Pharmaceutical Industries' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 3.2% in the same period.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for API? You can find out in our latest intrinsic value infographic research report.