Abbott Laboratories' (NYSE:ABT) stock is up by a considerable 21% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. In this article, we decided to focus on Abbott Laboratories' ROE.

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.

View our latest analysis for Abbott Laboratories

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 Abbott Laboratories is:

28% = US$13b ÷ US$48b (Based on the trailing twelve months to December 2024).

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 $0.28 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

A Side By Side comparison of Abbott Laboratories' Earnings Growth And 28% ROE

Firstly, we acknowledge that Abbott Laboratories has a significantly high ROE. Secondly, even when compared to the industry average of 13% the company's ROE is quite impressive. This likely paved the way for the modest 13% net income growth seen by Abbott Laboratories over the past five years.

As a next step, we compared Abbott Laboratories' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 13% in the same 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 ABT worth today? The intrinsic value infographic in our free research report helps visualize whether ABT is currently mispriced by the market.

Is Abbott Laboratories Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 59% (or a retention ratio of 41%) for Abbott Laboratories suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Additionally, Abbott Laboratories 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. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 45% over the next three years. Regardless, the future ROE for Abbott Laboratories is predicted to decline to 22% despite the anticipated decrease in the payout ratio. We reckon that there could probably be other factors that could be driving the forseen decline in the company's ROE.

Conclusion

Overall, we are quite pleased with Abbott Laboratories' performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. 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.