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It is hard to get excited after looking at AFT Pharmaceuticals' (NZSE:AFT) recent performance, when its stock has declined 9.8% over the past week. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study AFT Pharmaceuticals' ROE in this article.
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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
View our latest analysis for AFT Pharmaceuticals
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 AFT Pharmaceuticals is:
18% = NZ$16m ÷ NZ$88m (Based on the trailing twelve months to March 2024).
The 'return' is the yearly profit. One way to conceptualize this is that for each NZ$1 of shareholders' capital it has, the company made NZ$0.18 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.
AFT Pharmaceuticals' Earnings Growth And 18% ROE
To start with, AFT Pharmaceuticals' ROE looks acceptable. Further, the company's ROE is similar to the industry average of 19%. This certainly adds some context to AFT Pharmaceuticals' exceptional 20% net income growth seen over the past five years. However, there could also be other drivers behind this growth. Such as - high earnings retention or an efficient management in place.
As a next step, we compared AFT Pharmaceuticals' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 36% in the same period.
Earnings growth is an important metric to consider when valuing a stock. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if AFT Pharmaceuticals is trading on a high P/E or a low P/E, relative to its industry.