editorial-team@simplywallst.com (Simply Wall St)
·4 min read
Merck's (NYSE:MRK) stock is up by a considerable 18% over the past three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Specifically, we decided to study Merck'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 Merck
How Is ROE Calculated?
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:
1.0% = US$377m ÷ US$38b (Based on the trailing twelve months to December 2023).
The 'return' is the yearly profit. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.01 in profit.
What Has ROE Got To Do With Earnings Growth?
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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Merck's Earnings Growth And 1.0% ROE
It is hard to argue that Merck's ROE is much good in and of itself. Even when compared to the industry average of 18%, the ROE figure is pretty disappointing. Therefore, Merck's flat earnings over the past five years can possibly be explained by the low ROE amongst other factors.
Next, on comparing with the industry net income growth, we found that Merck's reported growth was lower than the industry growth of 3.8% over the last few years, which is not something we like to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Merck's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Merck Efficiently Re-investing Its Profits?
Merck's very high three-year median payout ratio of 110% suggests that the company is paying its shareholders more than what it is earning. The absence in growth is therefore not surprising. Its usually very hard to sustain dividend payments that are higher than reported profits. This is quite a risky position to be in. You can see the 5 risks we have identified for Merck by visiting our risks dashboard for free on our platform here.
In addition, Merck has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 35% over the next three years. The fact that the company's ROE is expected to rise to 38% over the same period is explained by the drop in the payout ratio.
Summary
On the whole, Merck's performance is quite a big let-down. 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. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.
