Could The Market Be Wrong About Sonic Healthcare Limited (ASX:SHL) Given Its Attractive Financial Prospects?
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With its stock down 8.7% over the past three months, it is easy to disregard Sonic Healthcare (ASX:SHL). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Sonic Healthcare's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
View our latest analysis for Sonic Healthcare
How Do You 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 Sonic Healthcare is:
6.8% = AU$534m ÷ AU$7.9b (Based on the trailing twelve months to December 2023).
The 'return' is the profit over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.07 in profit.
What Is The Relationship Between ROE And 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 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.
Sonic Healthcare's Earnings Growth And 6.8% ROE
When you first look at it, Sonic Healthcare's ROE doesn't look that attractive. However, the fact that the company's ROE is higher than the average industry ROE of 4.7%, is definitely interesting. This probably goes some way in explaining Sonic Healthcare's moderate 10% growth over the past five years amongst other factors. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. So there might well be other reasons for the earnings to grow. For example, it is possible that the broader industry is going through a high growth phase, or that the company has a low payout ratio.
We then compared Sonic Healthcare's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 1.5% in the same 5-year period.
