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It is hard to get excited after looking at CVS Health's (NYSE:CVS) recent performance, when its stock has declined 7.6% over the past month. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to CVS Health's ROE today.
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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
View our latest analysis for CVS Health
How Is ROE Calculated?
ROE 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 CVS Health is:
4.5% = US$3.2b ÷ US$71b (Based on the trailing twelve months to September 2022).
The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.04.
Why Is ROE Important For 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. 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.
CVS Health's Earnings Growth And 4.5% ROE
At first glance, CVS Health's ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 13%. Although, we can see that CVS Health saw a modest net income growth of 14% over the past five years. So, the growth in the company's earnings could probably have been caused by other variables. For instance, the company has a low payout ratio or is being managed efficiently.
As a next step, we compared CVS Health's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 16% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. What is CVS worth today? The intrinsic value infographic in our free research report helps visualize whether CVS is currently mispriced by the market.