It is hard to get excited after looking at Abbott Laboratories' (NYSE:ABT) recent performance, when its stock has declined 5.1% over the past month. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Abbott Laboratories' 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. Put another way, it reveals the company's success at turning shareholder investments into profits.
How Is ROE Calculated?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Abbott Laboratories is:
23% = US$8.6b ÷ US$37b (Based on the trailing twelve months to June 2022).
The 'return' refers to a company's earnings over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.23 in profit.
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.
Abbott Laboratories' Earnings Growth And 23% ROE
Firstly, we acknowledge that Abbott Laboratories 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 42% net income growth seen by Abbott Laboratories over the past five years isn't overly surprising.
As a next step, we compared Abbott Laboratories' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 20%.
Earnings growth is an important metric to consider when valuing a stock. 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. What is ABT worth today? The intrinsic value infographic in our free research report helps visualize whether ABT is currently mispriced by the market.
Is Abbott Laboratories Using Its Retained Earnings Effectively?
The high three-year median payout ratio of 61% (implying that it keeps only 39% of profits) for Abbott Laboratories suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.
Moreover, Abbott Laboratories is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 40% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.
Overall, we are quite pleased with Abbott Laboratories' performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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