It is hard to get excited after looking at AFT Pharmaceuticals' (NZSE:AFT) recent performance, when its stock has declined 16% 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 AFT Pharmaceuticals' ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for AFT Pharmaceuticals

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 AFT Pharmaceuticals is:

14% = NZ$11m ÷ NZ$84m (Based on the trailing twelve months to September 2024).

The 'return' is the profit over the last twelve months. That means that for every NZ$1 worth of shareholders' equity, the company generated NZ$0.14 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

AFT Pharmaceuticals' Earnings Growth And 14% ROE

At first glance, AFT Pharmaceuticals seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 13%. Consequently, this likely laid the ground for the decent growth of 9.7% seen over the past five years by AFT Pharmaceuticals.

We then compared AFT Pharmaceuticals' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 35% in the same 5-year period, which is a bit concerning.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 AFT Pharmaceuticals''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is AFT Pharmaceuticals Making Efficient Use Of Its Profits?

AFT Pharmaceuticals' three-year median payout ratio to shareholders is 11% (implying that it retains 89% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

While AFT Pharmaceuticals has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 19% over the next three years. Regardless, the future ROE for AFT Pharmaceuticals is speculated to rise to 17% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.

Conclusion

In total, we are pretty happy with AFT Pharmaceuticals' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.