In This Article:
Most readers would already be aware that Gerresheimer's (ETR:GXI) stock increased significantly by 27% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study Gerresheimer's 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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
Check out our latest analysis for Gerresheimer
How Is ROE Calculated?
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 Gerresheimer is:
7.3% = €96m ÷ €1.3b (Based on the trailing twelve months to August 2022).
The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every €1 worth of equity, the company was able to earn €0.07 in profit.
What Is The Relationship Between ROE And 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.
Gerresheimer's Earnings Growth And 7.3% ROE
At first glance, Gerresheimer's ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 12% either. Therefore, it might not be wrong to say that the five year net income decline of 11% seen by Gerresheimer was probably the result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
That being said, we compared Gerresheimer's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 29% 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. Doing so will help them establish if the stock's future looks promising or ominous. 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 Gerresheimer is trading on a high P/E or a low P/E, relative to its industry.