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With its stock down 34% over the past three months, it is easy to disregard Catalyst Pharmaceuticals (NASDAQ:CPRX). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Catalyst Pharmaceuticals' ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.
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 Catalyst Pharmaceuticals is:
38% = US$42m ÷ US$111m (Based on the trailing twelve months to June 2020).
The 'return' is the profit over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.38.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
Catalyst Pharmaceuticals' Earnings Growth And 38% ROE
First thing first, we like that Catalyst Pharmaceuticals has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 14% also doesn't go unnoticed by us. As a result, Catalyst Pharmaceuticals' exceptional 39% net income growth seen over the past five years, doesn't come as a surprise.
As a next step, we compared Catalyst Pharmaceuticals' 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 22%.
Earnings growth is a huge factor in stock valuation. 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. 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 Catalyst Pharmaceuticals is trading on a high P/E or a low P/E, relative to its industry.
Is Catalyst Pharmaceuticals Using Its Retained Earnings Effectively?
Overall, we are quite pleased with Catalyst Pharmaceuticals' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. 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 latest analysts predictions for the company, check out this visualization of analyst forecasts 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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