Innoviva (NASDAQ:INVA) has had a rough month with its share price down 11%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Innoviva's ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
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 Innoviva is:
48% = US$294m ÷ US$608m (Based on the trailing twelve months to December 2020).
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 $0.48 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.
Innoviva's Earnings Growth And 48% ROE
To begin with, Innoviva has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 17% which is quite remarkable. So, the substantial 36% net income growth seen by Innoviva over the past five years isn't overly surprising.
As a next step, we compared Innoviva's 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 21%.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Innoviva's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Innoviva Using Its Retained Earnings Effectively?
Given that Innoviva doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.
In total, we are pretty happy with Innoviva's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. To know the 1 risk we have identified for Innoviva visit our risks dashboard for free.
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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