Novartis AG (VTX:NOVN) Stock's Been Sliding But Fundamentals Look Decent: Will The Market Correct The Share Price In The Future?

It is hard to get excited after looking at Novartis' (VTX:NOVN) recent performance, when its stock has declined 8.6% over the past month. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Novartis' 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.

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How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Novartis is:

27% = US$12b ÷ US$44b (Based on the trailing twelve months to December 2024).

The 'return' is the profit over the last twelve months. So, this means that for every CHF1 of its shareholder's investments, the company generates a profit of CHF0.27.

Check out our latest analysis for Novartis

What Is The Relationship Between ROE And 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.

Novartis' Earnings Growth And 27% ROE

First thing first, we like that Novartis has an impressive ROE. Further, even comparing with the industry average if 25%, the company's ROE is quite respectable. However, for some reason, the higher returns aren't reflected in Novartis' meagre five year net income growth average of 3.2%.Despite this, Novartis' five year net income growth was quite low averaging at only 3.2%.Yet, Novartis has posted measly growth of 3.2% over the past five years. That's a bit unexpected from a company which has such a high rate of return. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

As a next step, we compared Novartis' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 11% in the same period.

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. Is Novartis fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Novartis Making Efficient Use Of Its Profits?

Novartis has a three-year median payout ratio of 80% (implying that it keeps only 20% of its profits), meaning that it pays out most of its profits to shareholders as dividends, and as a result, the company has seen low earnings growth.

Additionally, Novartis has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 44% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 36%, over the same period.

Summary

On the whole, we do feel that Novartis has some positive attributes. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.

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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.