Yahoo Finance Are Robust Financials Driving The Recent Rally In Merck & Co., Inc.'s (NYSE:MRK) Stock?
Merck's (NYSE:MRK) stock is up by a considerable 18% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Merck's 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.
View our latest analysis for Merck
How To Calculate Return On Equity?
ROE 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 Merck is:
34% = US$15b ÷ US$45b (Based on the trailing twelve months to September 2022).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.34 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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.
A Side By Side comparison of Merck's Earnings Growth And 34% ROE
First thing first, we like that Merck has an impressive ROE. Additionally, the company's ROE is higher compared to the industry average of 19% which is quite remarkable. As a result, Merck's exceptional 28% net income growth seen over the past five years, doesn't come as a surprise.
As a next step, we compared Merck's 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 14%.
Earnings growth is an important metric to consider when valuing a stock. 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 MRK fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Merck Efficiently Re-investing Its Profits?
Merck has a significant three-year median payout ratio of 64%, meaning the company only retains 36% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.
Additionally, Merck 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 37% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.
Summary
In total, we are pretty happy with Merck's performance. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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.
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