Could The Market Be Wrong About Sonic Healthcare Limited (ASX:SHL) Given Its Attractive Financial Prospects?

It is hard to get excited after looking at Sonic Healthcare's (ASX:SHL) recent performance, when its stock has declined 6.8% over the past three months. 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 Sonic 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Sonic Healthcare

How Is ROE Calculated?

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 Sonic Healthcare is:

20% = AU$1.5b ÷ AU$7.4b (Based on the trailing twelve months to June 2022).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.20 in profit.

Why Is ROE Important For 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. 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.

Sonic Healthcare's Earnings Growth And 20% ROE

At first glance, Sonic Healthcare seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 7.2%. This probably laid the ground for Sonic Healthcare's significant 30% net income growth seen over the past five years. However, there could also be other causes behind this 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.

Next, on comparing with the industry net income growth, we found that Sonic Healthcare's growth is quite high when compared to the industry average growth of 10% in the same period, which is great to see.

past-earnings-growth
past-earnings-growth

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for SHL? You can find out in our latest intrinsic value infographic research report.

Is Sonic Healthcare Making Efficient Use Of Its Profits?

The three-year median payout ratio for Sonic Healthcare is 44%, which is moderately low. The company is retaining the remaining 56%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Sonic Healthcare is reinvesting its earnings efficiently.

Besides, Sonic Healthcare has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 68% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 9.8% over the same period.

Conclusion

Overall, we are quite pleased with Sonic Healthcare's performance. 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. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.

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