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It is hard to get excited after looking at Enanta Pharmaceuticals' (NASDAQ:ENTA) recent performance, when its stock has declined 4.3% over the past three months. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. In this article, we decided to focus on Enanta Pharmaceuticals' ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
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 Enanta Pharmaceuticals is:
4.9% = US$24m ÷ US$486m (Based on the trailing twelve months to March 2020).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.05 in profit.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
Enanta Pharmaceuticals' Earnings Growth And 4.9% ROE
On the face of it, Enanta Pharmaceuticals' ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 19% either. Therefore, it might not be wrong to say that the five year net income decline of 2.8% seen by Enanta Pharmaceuticals was probably the result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.
That being said, we compared Enanta Pharmaceuticals' performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 23% in the same period.
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. If you're wondering about Enanta Pharmaceuticals''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Enanta Pharmaceuticals Using Its Retained Earnings Effectively?
Enanta Pharmaceuticals doesn't pay any dividend, meaning that the company is keeping all of its profits, which makes us wonder why it is retaining its earnings if it can't use them to grow its business. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.
Overall, we have mixed feelings about Enanta Pharmaceuticals. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. In addition, on studying the latest analyst forecasts, we found that the company's earnings are expected to continue to shrink. 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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