Could The Market Be Wrong About Zydus Lifesciences Limited (NSE:ZYDUSLIFE) Given Its Attractive Financial Prospects?

With its stock down 11% over the past three months, it is easy to disregard Zydus Lifesciences (NSE:ZYDUSLIFE). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Zydus Lifesciences' 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.

View our latest analysis for Zydus Lifesciences

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 Zydus Lifesciences is:

19% = ₹43b ÷ ₹221b (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.19 in profit.

What Is The Relationship Between ROE And 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. 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.

Zydus Lifesciences' Earnings Growth And 19% ROE

To start with, Zydus Lifesciences' ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 12%. This certainly adds some context to Zydus Lifesciences' decent 19% net income growth seen over the past five years.

As a next step, we compared Zydus Lifesciences' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 15%.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Zydus Lifesciences''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Zydus Lifesciences Efficiently Re-investing Its Profits?

In Zydus Lifesciences' case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 13% (or a retention ratio of 87%), which suggests that the company is investing most of its profits to grow its business.

Besides, Zydus Lifesciences has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 13%. Accordingly, forecasts suggest that Zydus Lifesciences' future ROE will be 17% which is again, similar to the current ROE.

Conclusion

On the whole, we feel that Zydus Lifesciences' performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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.