Alliance Pharma’s (LON:APH) stock is up by a considerable 6.7% over the past week. We wonder if and what role the company’s financials play in that price change as a company’s long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Alliance Pharma’s ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company’s management is utilizing the company’s capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out our latest analysis for Alliance Pharma
How Do You Calculate Return On Equity?
ROE 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 Alliance Pharma is:
9.1% = UK£25m ÷ UK£274m (Based on the trailing twelve months to December 2019).
The ‘return’ is the amount earned after tax over the last twelve months. So, this means that for every £1 of its shareholder’s investments, the company generates a profit of £0.09.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or “retains” for future growth which then gives us an idea about the growth potential of the company. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don’t necessarily bear these characteristics.
Alliance Pharma’s Earnings Growth And 9.1% ROE
At first glance, Alliance Pharma’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 15% either. Although, we can see that Alliance Pharma saw a modest net income growth of 17% over the past five years. So, there might be other aspects that are positively influencing the company’s earnings growth. For example, it is possible that the company’s management has made some good strategic decisions, or that the company has a low payout ratio.
Next, on comparing with the industry net income growth, we found that Alliance Pharma’s 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. 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. Has the market priced in the future outlook for APH? You can find out in our latest intrinsic value infographic research report.
Is Alliance Pharma Making Efficient Use Of Its Profits?
With a three-year median payout ratio of 27% (implying that the company retains 73% of its profits), it seems that Alliance Pharma is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that’s well covered.
Upon studying the latest analysts’ consensus data, we found that the company’s future payout ratio is expected to rise to 34% over the next three years. Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.
Summary
Overall, we feel that Alliance Pharma certainly does have some positive factors to consider. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. Having said that, the company’s earnings growth is expected to slow down, as forecasted in the current analyst estimates. Are these analysts expectations based on the broad expectations for the industry, or on the company’s fundamentals? Click here to be taken to our analyst’s forecasts page for the company.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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