Vita Life Sciences Limited's (ASX:VLS) Stock Is Going Strong: Have Financials A Role To Play?
Most readers would already be aware that Vita Life Sciences' (ASX:VLS) stock increased significantly by 15% over the past month. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Specifically, we decided to study Vita Life Sciences' ROE in this article.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
Check out our latest analysis for Vita Life Sciences
How To Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Vita Life Sciences is:
22% = AU$5.1m ÷ AU$23m (Based on the trailing twelve months to June 2020).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.22 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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.
Vita Life Sciences' Earnings Growth And 22% ROE
To start with, Vita Life Sciences' ROE looks acceptable. On comparing with the average industry ROE of 17% the company's ROE looks pretty remarkable. For this reason, Vita Life Sciences' five year net income decline of 7.3% raises the question as to why the high ROE didn't translate into earnings growth. We reckon that there could be some other factors at play here that are preventing the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
With the industry earnings declining at a rate of 7.3% in the same period, we deduce that both the company and the industry are shrinking at the same rate.
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 Vita Life Sciences is trading on a high P/E or a low P/E, relative to its industry.
Is Vita Life Sciences Making Efficient Use Of Its Profits?
With a high three-year median payout ratio of 72% (implying that 28% of the profits are retained), most of Vita Life Sciences' profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely. To know the 3 risks we have identified for Vita Life Sciences visit our risks dashboard for free.
In addition, Vita Life Sciences has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.
Summary
On the whole, we do feel that Vita Life Sciences has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. You can do your own research on Vita Life Sciences and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.
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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