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Pro Medicus (ASX:PME) has had a rough three months with its share price down 23%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Pro Medicus' ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out our latest analysis for Pro Medicus
How Is ROE Calculated?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Pro Medicus is:
40% = AU$38m ÷ AU$95m (Based on the trailing twelve months to December 2021).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.40 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
A Side By Side comparison of Pro Medicus' Earnings Growth And 40% ROE
To begin with, Pro Medicus has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 12% also doesn't go unnoticed by us. As a result, Pro Medicus' exceptional 31% net income growth seen over the past five years, doesn't come as a surprise.
We then compared Pro Medicus' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 41% in the same period, which is a bit concerning.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Pro Medicus''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.