Is Weakness In Eurofins Scientific SE (EPA:ERF) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

Simply Wall St · 09/15/2023 07:42

With its stock down 10% over the past three months, it is easy to disregard Eurofins Scientific (EPA:ERF). 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. In this article, we decided to focus on Eurofins Scientific's ROE.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Eurofins Scientific

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 Eurofins Scientific is:

8.8% = €448m ÷ €5.1b (Based on the trailing twelve months to June 2023).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each €1 of shareholders' capital it has, the company made €0.09 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. 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.

Eurofins Scientific's Earnings Growth And 8.8% ROE

At first glance, Eurofins Scientific seems to have a decent ROE. Even so, when compared with the average industry ROE of 11%, we aren't very excited. That being the case, the significant five-year 29% net income growth reported by Eurofins Scientific comes as a pleasant surprise. We believe that there might be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio. Bear in mind, the company does have a respectable ROE. It is just that the industry ROE is higher. So this certainly also provides some context to the high earnings growth seen by the company.

We then performed a comparison between Eurofins Scientific's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 29% in the same 5-year period.

past-earnings-growth
ENXTPA:ERF Past Earnings Growth September 15th 2023

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. What is ERF worth today? The intrinsic value infographic in our free research report helps visualize whether ERF is currently mispriced by the market.

Is Eurofins Scientific Using Its Retained Earnings Effectively?

Eurofins Scientific's three-year median payout ratio is a pretty moderate 28%, meaning the company retains 72% of its income. So it seems that Eurofins Scientific is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Moreover, Eurofins Scientific is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 30% of its profits over the next three years. However, Eurofins Scientific's ROE is predicted to rise to 11% despite there being no anticipated change in its payout ratio.

Conclusion

In total, we are pretty happy with Eurofins Scientific's performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.