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Most readers would already be aware that Cochlear's (ASX:COH) stock increased significantly by 6.7% over the past month. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. In this article, we decided to focus on Cochlear's ROE.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
See our latest analysis for Cochlear
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 Cochlear is:
17% = AU$301m ÷ AU$1.7b (Based on the trailing twelve months to June 2023).
The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.17 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
Cochlear's Earnings Growth And 17% ROE
To start with, Cochlear's ROE looks acceptable. Especially when compared to the industry average of 9.3% the company's ROE looks pretty impressive. This certainly adds some context to Cochlear's decent 5.8% net income growth seen over the past five years.
Next, on comparing Cochlear's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 5.8% over the last few years.
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. If you're wondering about Cochlear's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.