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With its stock down 13% over the past three months, it is easy to disregard Vita Life Sciences (ASX:VLS). 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. In this article, we decided to focus on Vita Life Sciences' ROE.
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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How To Calculate Return On Equity?
Return on equity 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 Vita Life Sciences is:
27% = AU$8.2m ÷ AU$30m (Based on the trailing twelve months to December 2021).
The 'return' is the profit over the last twelve months. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.27.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 27% ROE
First thing first, we like that Vita Life Sciences has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 18% also doesn't go unnoticed by us. So, the substantial 24% net income growth seen by Vita Life Sciences over the past five years isn't overly surprising.
As a next step, we compared Vita Life Sciences' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 40% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is Vita Life Sciences fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Vita Life Sciences Efficiently Re-investing Its Profits?
Vita Life Sciences' three-year median payout ratio is a pretty moderate 43%, meaning the company retains 57% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Vita Life Sciences is reinvesting its earnings efficiently.
Moreover, Vita Life Sciences 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.
In total, we are pretty happy with Vita Life Sciences' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. 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. You can see the 4 risks we have identified for Vita Life Sciences by visiting our risks dashboard for free on our platform here.
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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.