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It is hard to get excited after looking at Pro Medicus' (ASX:PME) recent performance, when its stock has declined 21% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Pro Medicus' ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
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How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Pro Medicus is:
44% = AU$98m ÷ AU$222m (Based on the trailing twelve months to December 2024).
The 'return' is the profit over the last twelve months. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.44.
See our latest analysis for Pro Medicus
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.
Pro Medicus' Earnings Growth And 44% ROE
Firstly, we acknowledge that Pro Medicus has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 11% which is quite remarkable. So, the substantial 31% net income growth seen by Pro Medicus over the past five years isn't overly surprising.
Next, on comparing with the industry net income growth, we found that Pro Medicus' growth is quite high when compared to the industry average growth of 13% in the same period, which is great to see.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is Pro Medicus fairly valued compared to other companies? These 3 valuation measures might help you decide.