Pro Medicus Limited's (ASX:PME) Stock Is Going Strong: Is the Market Following Fundamentals?
Pro Medicus (ASX:PME) has had a great run on the share market with its stock up by a significant 28% over the last three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Specifically, we decided to study Pro Medicus' 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out our latest analysis for Pro Medicus
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 Pro Medicus is:
44% = AU$61m ÷ AU$139m (Based on the trailing twelve months to June 2023).
The 'return' refers to a company's earnings over the last year. That means that for every A$1 worth of shareholders' equity, the company generated A$0.44 in profit.
What Has ROE Got To Do With 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.
Pro Medicus' Earnings Growth And 44% ROE
Firstly, we acknowledge that Pro Medicus has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 9.6% also doesn't go unnoticed by us. As a result, Pro Medicus' exceptional 30% net income growth seen over the past five years, doesn't come as a surprise.
As a next step, we compared Pro Medicus' 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 16%.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Pro Medicus is trading on a high P/E or a low P/E, relative to its industry.
Is Pro Medicus Efficiently Re-investing Its Profits?
Pro Medicus has a significant three-year median payout ratio of 51%, meaning the company only retains 49% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.
Additionally, Pro Medicus has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. 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 52%. As a result, Pro Medicus' ROE is not expected to change by much either, which we inferred from the analyst estimate of 45% for future ROE.
Summary
Overall, we are quite pleased with Pro Medicus' performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.
