Dechra Pharmaceuticals (LON:DPH) has had a rough three months with its share price down 3.7%. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. In this article, we decided to focus on Dechra Pharmaceuticals' ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
See our latest analysis for Dechra Pharmaceuticals
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Dechra Pharmaceuticals is:
8.8% = UK£56m ÷ UK£633m (Based on the trailing twelve months to June 2021).
The 'return' is the profit over the last twelve months. That means that for every £1 worth of shareholders' equity, the company generated £0.09 in profit.
What Is The Relationship Between ROE And 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
Dechra Pharmaceuticals' Earnings Growth And 8.8% ROE
At first glance, Dechra Pharmaceuticals' ROE doesn't look very promising. However, its ROE is similar to the industry average of 8.8%, so we won't completely dismiss the company. On the other hand, Dechra Pharmaceuticals reported a moderate 18% net income growth over the past five years. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. For instance, the company has a low payout ratio or is being managed efficiently.
Next, on comparing with the industry net income growth, we found that the growth figure reported by Dechra Pharmaceuticals compares quite favourably to the industry average, which shows a decline of 5.4% in the same period.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Dechra Pharmaceuticals fairly valued compared to other companies? These 3 valuation measures might help you decide.