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Is Dechra Pharmaceuticals PLC's (LON:DPH) Stock Price Struggling As A Result Of Its Mixed Financials?

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Dechra Pharmaceuticals (LON:DPH) has had a rough three months with its share price down 3.7%. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. In this article, we decided to focus on Dechra 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Dechra Pharmaceuticals

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 Dechra Pharmaceuticals is:

8.8% = UK£56m ÷ UK£633m (Based on the trailing twelve months to June 2021).

The 'return' is the profit over the last twelve months. That means that for every £1 worth of shareholders' equity, the company generated £0.09 in profit.

What Is The Relationship Between ROE And 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. 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.

Dechra Pharmaceuticals' Earnings Growth And 8.8% ROE

At first glance, Dechra Pharmaceuticals' ROE doesn't look very promising. However, its ROE is similar to the industry average of 8.8%, so we won't completely dismiss the company. On the other hand, Dechra Pharmaceuticals reported a moderate 18% net income growth over the past five years. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that the growth figure reported by Dechra Pharmaceuticals compares quite favourably to the industry average, which shows a decline of 5.4% in the same period.

past-earnings-growth
past-earnings-growth

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Dechra Pharmaceuticals fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Dechra Pharmaceuticals Using Its Retained Earnings Effectively?

Dechra Pharmaceuticals' high three-year median payout ratio of 104% suggests that the company is paying out more to its shareholders than what it is making. In spite of this, the company was able to grow its earnings respectably, as we saw above. That being said, the high payout ratio could be worth keeping an eye on in case the company is unable to keep up its current growth momentum.

Additionally, Dechra Pharmaceuticals 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. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 38% over the next three years. The fact that the company's ROE is expected to rise to 20% over the same period is explained by the drop in the payout ratio.

Summary

In total, we're a bit ambivalent about Dechra Pharmaceuticals' performance. While the company has posted impressive earnings growth, its poor ROE and low earnings retention makes us doubtful if that growth could continue, if by any chance the business is faced with any sort of risk. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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