Could The Market Be Wrong About Hikma Pharmaceuticals PLC (LON:HIK) Given Its Attractive Financial Prospects?
With its stock down 15% over the past three months, it is easy to disregard Hikma Pharmaceuticals (LON:HIK). 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 Hikma Pharmaceuticals' 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.
View our latest analysis for Hikma Pharmaceuticals
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 Hikma Pharmaceuticals is:
16% = US$346m ÷ US$2.2b (Based on the trailing twelve months to June 2022).
The 'return' is the income the business earned over the last year. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.16.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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. 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.
Hikma Pharmaceuticals' Earnings Growth And 16% ROE
To begin with, Hikma Pharmaceuticals seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 16%. This certainly adds some context to Hikma Pharmaceuticals' exceptional 46% net income growth seen over the past five years. However, there could also be other drivers behind this growth. Such as - high earnings retention or an efficient management in place.
Next, on comparing with the industry net income growth, we found that Hikma Pharmaceuticals' growth is quite high when compared to the industry average growth of 17% in the same period, which is great to see.
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. If you're wondering about Hikma Pharmaceuticals''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Hikma Pharmaceuticals Using Its Retained Earnings Effectively?
Hikma Pharmaceuticals has a three-year median payout ratio of 26% (where it is retaining 74% of its income) which is not too low or not too high. By the looks of it, the dividend is well covered and Hikma Pharmaceuticals is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.
Moreover, Hikma Pharmaceuticals 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 27% of its profits over the next three years. As a result, Hikma Pharmaceuticals' ROE is not expected to change by much either, which we inferred from the analyst estimate of 17% for future ROE.
Conclusion
In total, we are pretty happy with Hikma Pharmaceuticals' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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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