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Declining Stock and Solid Fundamentals: Is The Market Wrong About Sonic Healthcare Limited (ASX:SHL)?

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It is hard to get excited after looking at Sonic Healthcare's (ASX:SHL) recent performance, when its stock has declined 7.2% over the past week. 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 Sonic Healthcare's ROE in this article.

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.

See our latest analysis for Sonic Healthcare

How Is ROE Calculated?

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 Sonic Healthcare is:

21% = AU$1.5b ÷ AU$7.2b (Based on the trailing twelve months to December 2021).

The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.21 in profit.

What Has ROE Got To Do With 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Sonic Healthcare's Earnings Growth And 21% ROE

To begin with, Sonic Healthcare seems to have a respectable ROE. Especially when compared to the industry average of 8.2% the company's ROE looks pretty impressive. This probably laid the ground for Sonic Healthcare's significant 27% net income growth seen over the past five years. We believe that there might also 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.

When you consider the fact that the industry earnings have shrunk at a rate of 0.1% in the same period, the company's net income growth is pretty remarkable.

past-earnings-growth
past-earnings-growth

Earnings growth is a huge factor in stock valuation. 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. Is SHL fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Sonic Healthcare Efficiently Re-investing Its Profits?

Sonic Healthcare's significant three-year median payout ratio of 69% (where it is retaining only 31% of its income) suggests that the company has been able to achieve a high growth in earnings despite returning most of its income to shareholders.

Moreover, Sonic Healthcare 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 68%. However, Sonic Healthcare's future ROE is expected to decline to 9.9% despite there being not much change anticipated in the company's payout ratio.

Summary

Overall, we are quite pleased with Sonic Healthcare's 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. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.