Santen Pharmaceutical (TSE:4536) has had a rough three months with its share price down 2.3%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Santen Pharmaceutical’s ROE in this article.
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.
Check out our latest analysis for Santen Pharmaceutical
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 Santen Pharmaceutical is:
9.3% = JP¥28b ÷ JP¥298b (Based on the trailing twelve months to December 2023).
The ‘return’ is the yearly profit. One way to conceptualize this is that for each ¥1 of shareholders’ capital it has, the company made ¥0.09 in profit.
Why Is ROE Important For Earnings Growth?
So far, we’ve learned that ROE is a measure of a company’s profitability. 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 Santen Pharmaceutical’s Earnings Growth And 9.3% ROE
At first glance, Santen Pharmaceutical seems to have a decent ROE. On comparing with the average industry ROE of 6.3% the company’s ROE looks pretty remarkable. Needless to say, we are quite surprised to see that Santen Pharmaceutical’s net income shrunk at a rate of 29% over the past five years. Therefore, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.
That being said, we compared Santen Pharmaceutical’s performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 3.6% in the same 5-year period.
Earnings growth is an important metric to consider when valuing a stock. 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. What is 4536 worth today? The intrinsic value infographic in our free research report helps visualize whether 4536 is currently mispriced by the market.
Is Santen Pharmaceutical Efficiently Re-investing Its Profits?
Looking at its three-year median payout ratio of 46% (or a retention ratio of 54%) which is pretty normal, Santen Pharmaceutical’s declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
Additionally, Santen Pharmaceutical has paid dividends over a period of at least ten years, which means that the company’s management is determined to pay dividends even if it means little to no earnings growth.
Conclusion
In total, it does look like Santen Pharmaceutical has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. 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 company’s future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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Find out whether Santen Pharmaceutical 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.
