Fisher & Paykel Healthcare's (NZSE:FPH) stock up by 9.9% over the past three months. Given that the markets usually pay for the long-term financial health of a company, we wonder if the current momentum in the share price will keep up, given that the company's financials don't look very promising. Particularly, we will be paying attention to Fisher & Paykel Healthcare's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Fisher & Paykel Healthcare

How To Calculate Return On Equity?

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 Fisher & Paykel Healthcare is:

7.5% = NZ$133m ÷ NZ$1.8b (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned over the last year. So, this means that for every NZ$1 of its shareholder's investments, the company generates a profit of NZ$0.08.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of Fisher & Paykel Healthcare's Earnings Growth And 7.5% ROE

When you first look at it, Fisher & Paykel Healthcare's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.4%. But Fisher & Paykel Healthcare saw a five year net income decline of 4.6% over the past five years. Remember, the company's ROE is a bit low to begin with. So that's what might be causing earnings growth to shrink.

However, when we compared Fisher & Paykel Healthcare's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 7.5% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. 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 Fisher & Paykel Healthcare's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Fisher & Paykel Healthcare Making Efficient Use Of Its Profits?

Fisher & Paykel Healthcare has a high three-year median payout ratio of 91% (that is, it is retaining 9.2% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only very little left to reinvest into the business, growth in earnings is far from likely. To know the 3 risks we have identified for Fisher & Paykel Healthcare visit our risks dashboard for free.

In addition, Fisher & Paykel Healthcare 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 65% over the next three years. The fact that the company's ROE is expected to rise to 24% over the same period is explained by the drop in the payout ratio.

Summary

Overall, we would be extremely cautious before making any decision on Fisher & Paykel Healthcare. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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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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.