Stock Analysis
AstraZeneca (LON:AZN) has had a great run on the share market with its stock up by a significant 20% over the last three months. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. Specifically, we decided to study AstraZeneca's ROE in this article.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
View our latest analysis for AstraZeneca
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for AstraZeneca is:
5.8% = US$2.0b ÷ US$35b (Based on the trailing twelve months to September 2022).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.06 in profit.
So far, we've learned that ROE is a measure of a company's profitability. 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.
At first glance, AstraZeneca's ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 7.3% either. Therefore, it might not be wrong to say that the five year net income decline of 20% seen by AstraZeneca was probably the result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.
However, when we compared AstraZeneca's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 5.1% in the same period. This is quite worrisome.
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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for AZN? You can find out in our latest intrinsic value infographic research report.
With a three-year median payout ratio as high as 171%,AstraZeneca's shrinking earnings don't come as a surprise as the company is paying a dividend which is beyond its means. Paying a dividend higher than reported profits is not a sustainable move. You can see the 3 risks we have identified for AstraZeneca by visiting our risks dashboard for free on our platform here.
Moreover, AstraZeneca has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 34% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 30%, over the same period.
Overall, we would be extremely cautious before making any decision on AstraZeneca. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
Find out whether AstraZeneca is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.
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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.
AstraZeneca PLC, a biopharmaceutical company, focuses on the discovery, development, manufacturing, and commercialization of prescription medicines.
High growth potential with acceptable track record.
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