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It is hard to get excited after looking at Pro Medicus' (ASX:PME) recent performance, when its stock has declined 8.9% over the past month. 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 Pro Medicus' ROE in this article.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
See our latest analysis for Pro Medicus
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 Pro Medicus is:
42% = AU$22m ÷ AU$52m (Based on the trailing twelve months to December 2019).
The 'return' is the income the business earned over the last year. That means that for every A$1 worth of shareholders' equity, the company generated A$0.42 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. 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 42% ROE
Firstly, we acknowledge that Pro Medicus has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 12% also doesn't go unnoticed by us. Under the circumstances, Pro Medicus' considerable five year net income growth of 37% was to be expected.
Next, on comparing Pro Medicus' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 37% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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.