CVS Health Inc (NYSE:CVS) had a tough week with its stock price down 3.0%. However, a closer look at his healthy finances might make you think again. Since fundamentals generally determine long-term market outcomes, the company is worth looking into. In particular, we’ll be paying attention to CVS Health’s ROE today.
Return on equity or ROE is a key metric used to gauge how effectively a company’s management is using the company’s capital. In other words, it is a profitability ratio that measures the rate of return on capital contributed by the company’s shareholders.
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How is ROE calculated?
The return on equity formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for CVS Health is:
11% = US$8.2 billion ÷ US$76 billion (based on trailing 12 months to June 2022).
“Yield” refers to a company’s earnings over the past year. This therefore means that for every $1 of investment by its shareholder, the company generates a profit of $0.11.
Why is ROE important for earnings growth?
So far we have learned that ROE is a measure of a company’s profitability. We now need to assess how much profit the company is reinvesting or “retaining” for future growth, which then gives us an idea of the company’s growth potential. Assuming everything else remains unchanged, the higher the ROE and earnings retention, the higher a company’s growth rate relative to companies that don’t necessarily exhibit these characteristics.
CVS Health and ROE earnings growth of 11%
For starters, CVS Health seems to have a respectable ROE. Even so, compared to the industry average ROE of 15%, we are not very enthusiastic. CVS Health was still able to see a decent net income growth of 17% over the past five years. Thus, there could be other aspects that positively influence earnings growth. For example, it is possible that the management of the company has made good strategic decisions or that the company has a low payout ratio. However, it’s worth remembering that the company has a decent ROE to start with, just that it’s below the industry average. So this also provides some context for the earnings growth the company is seeing.
As a next step, we compared CVS Health’s net income growth with the industry and found that the company has a similar growth figure compared to the industry average growth rate of 18% over the course of the same period.
Earnings growth is an important metric to consider when evaluating a stock. What investors then need to determine is whether the expected earnings growth, or lack thereof, is already priced into the stock price. This then helps them determine if the stock is positioned for a bright or bleak future. If you’re wondering about CVS Health’s valuation, check out this indicator of its price-earnings ratio, relative to its sector.
Is CVS Health effectively using its benefits?
CVS Health has a healthy combination of a moderate three-year median payout rate of 35% (or a retention rate of 65%) and respectable earnings growth, as we saw above, this which means that the company has made efficient use of its profits.
Additionally, CVS Health is committed to continuing to share its earnings with shareholders, which we infer from its long history of paying dividends for at least ten years. Our latest analyst data shows the company’s future payout ratio is expected to drop to 24% over the next three years. As a result, the expected decline in CVS Health’s payout ratio explains the company’s expected future ROE rise to 15% over the same period.
Overall, we’re pretty happy with CVS Health’s performance. Specifically, we like that he reinvested a large portion of his profits at a moderate rate of return, which resulted in increased profits. That said, the latest forecasts from industry analysts show that the company’s earnings growth is expected to slow. To learn more about the latest analyst forecasts for the company, check out this analyst forecast visualization for the company.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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